If yet more money is introduced and spent in an economy that already has enough money for full employment then there is no more spare capacity available to absorb it, so the additional money is used by the people who first get it bid up prices for the things they want, and the increased profits allow the producers of those things to try to expand production and hire more workers. But since there is already full employment if more workers are taken on then they have to be paid more to tempt them away from other producers, who lose workers and their output drops, so their goods become more limited in supply and then their prices are bid up by people who want them, and they increase wages to tempt workers back again. Eventually the wage and price rises ripple through the economy until everything is as it was before, but with higher prices and wages all round to absorb the extra money that was introduced. If the increase in money is temporary then there will be a one-off increase in wages and prices but no more, and relatively little harm is done. Inflation will register in one year but not continue. If however new money continues to be introduced year after year then the same things will happen but there will be continuing inflation, and if significant then it can be very harmful.
When an economy with sufficient money for full employment experiences an increase in the money supply and spending, employment remains the same but prices and wages rise to absorb the increase, which is inflation.
If new money is introduced each year in substantial amounts then people become attuned to it. They recognise that their money is losing value so they spend it quickly by bidding prices up in order to rid themselves of it as quickly as possible. The effect triggers yet more inflation and makes it even more difficult to control. It is very harmful to many people, especially those on fixed incomes and those who have to live on savings.
Inflation also has a major impact on debts, in effect making debts that were taken on before inflation took off easier for borrowers to repay (provided that their incomes rise with inflation) and reducing the value of such debts to lenders. This can hit non-bank lenders hard, because inflation causes them to lose value as shown in the example below. Banks are different in that they don't lend anything of value so they have no value to lose, though they often apply variable interest rates, especially for long-term loans such as mortgages, to ensure that the interest they receive keeps up with inflation. The effect of inflation on bank lending is discussed in chapter 48.
Say a debt for a year of £100 is taken on at 5% interest, then £105 is payable at the year end. The £100 is used to buy goods at that value at the beginning of the year. If, however, there is inflation at 10% during the year then the price of goods rises 10% over the year, and the goods that were bought at the beginning of the year for £100 cost £110 at the end of the year. Hence the £105 that pays the debt off to the lender at the year-end is worth £5 less than its value at the outset, which is a loss to the lender and a gain to the borrower because he or she now has goods to the value of £110 that only cost £105. Because of this effect lenders always try to anticipate the level of inflation and add it to the desired rate of interest. They always get it wrong of course to a greater or lesser extent, because with the current monetary system future inflation is one of life's great unknowns. Deflation has the opposite effect on debts, making them more expensive to repay for borrowers and more valuable to lenders. Both effects are harmful.
The above reasoning shows that there is an amount of spending in an economy that is appropriate for full employment and allows the required quantity of legitimate transactions to be undertaken. More spending causes general increases in prices and wages, and less spending causes spare capacity and unemployment with uneven reductions in prices and wages. The quantity of money available in the economy should therefore be sufficient to enable the full employment level of spending to be undertaken together with an excess to allow for some money to be out of circulation.
It is important to note that inflation always occurs whenever the product sought isn't produced in sufficient quantity to keep up with demand. The above discussion has focused on the products of labour, when labour is in short supply because of full employment. Exactly the same effect is seen in assets such as property, equities (company shares) and debt, which don't appear in the most-often quoted measures of inflation - Retail Prices Index (RPI) and Consumer Prices Index (CPI), which combine baskets of commonly bought goods and services. When mortgages become easier to obtain house prices tend to rise because the housing stock can't increase at the same rate as demand, and when people have money in excess of their spending requirements they invest it in equities and debts, which again aren't produced in response to demand so their prices inflate, often significantly.
The rates of inflation or deflation are different for every product, and occur whenever demand for a product is higher or lower respectively than supply. If demand exceeds supply then the price inflates, and vice versa.