How should I think about increases in money supply and the subsequent impact on purchasing power?

If money supply (m1, m2, m3) increases by x%, does the real purchasing power of fiat currency decrease by x%? Why or why not? This is a great question, and like all great questions, the answer is: "It Depends." In this case, the correct answer depends on the growth rate of the economy, and the velocity of money. (See 's answer here:  )  In an ideal economy, the money supply increases in lockstep with economic growth, so that changes to the money supply don't influence prices.  In this ideal economy, changes to prices are solely the result of fluctuations in supply and demand, innovation, etc.  Since we don't live in a perfect world, and can't predict or measure economic growth perfectly in real time, we face two additional, and much more likely, possibilities.  If the money supply grows faster than the economy, we have inflation; if the economy grows faster than the money supply (or if the money supply contracts faster than the economy), we get deflation. For many reasons, deflation is a much bigger threat, and much harder to fight if it occurs.  As a result, inflation, despite its well-understood disadvantages, is always preferable to even the risk of deflation. All that said, on to your question:  if, in 2011, the money supply increases by 3% and the economy expands by 2%, we'll have (simplistically) 1% inflation (which, again simplistically, equates to a 1% decline in purchasing power).  But in January 2011 we had no perfect way of perfectly predicting the growth rate.  And deflation is much more damaging than inflation.  So economists and central bankers set a goal of a low rate of inflation (usually < 2%), and adjust as conditions change.  That little bit of inflation serves as a clear, unambiguous signal that we aren't experiencing deflation, and a consistent rate of inflation can be priced into e.g. bond prices.  Think of it as a "deflation insurance premium."