What I explain in this blog post is also answered in Richard Maybury’s book on inflation. (and more!) Link: The Money Mystery
There are thee stages of price inflation. we’ll start with the first one In the first stage of price inflation, this happens:
In the beginning the government starts printing money. After a while of printing money the money spreads into certain areas of the economy and prices rise, since every individual piece of money is worth less.
Demand for money. The demand for money is how much people are willing to hold the currency rather than spend it. The demand for money doesn’t decrease, because people are waiting for the prices to go down.
Velocity. Velocity is the speed money changes owners. Since people aren’t spending their money velocity stays the same or even decreases.
Next, in the second stage of price inflation it starts to fall apart. This is why:
The money supply is increasing, because the government is still printing money. Prices are still increasing.
Now people realize that prices won’t go down and start spending their money faster than they otherwise would have. Now the demand for money starts decreasing.
Then velocity increases, since people are trading money faster.
Then, in the third stage of price inflation chaos breaks out.
The government stops printing money and tries to put restrictions to increase demand for their currency. Prices are now extremely high.
People are trying to get rid of money as fast as possible or won’t accept it at all. even with tight regulations the demand for money is still decreasing. People who are accepting the money have to increase the prices to cushion the falling value of the currency. What is happening they call a runaway inflation or a hyperinflation.
Due to people trading away money very quickly velocity skyrockets.
The third stage of price inflation happened in Germany after World War I and to France after the French revolution. Price inflation doesn’t always reach the third stage.
To summarize, during the three stages of price inflation it becomes chaos. In stage one the governments start printing money. Then in stage two people realize what is happening and start spending. Last, in stage three it becomes a runaway inflation and the paper money is worthless. After that the economy is in shambles or somehow the economy recovers.