At the heart of financial instability and crisis are processes of inflation and deflation in credit or financial markets. This is one of the least understood aspects of finance, and it is usually wholly ignored in financial economics. Yet it is impossible to understand the seemingly permanent state of fluctuation in financial markets, or to conduct monetary policy effectively, without some insight into these processes.

Financial inflation is best described as the rise in the value of the financial sector of the economy (banking and finance) in relation to the value of the rest of the economy. For example, at the end of the twentieth century, the value of all financial assets in the United States was equal to more than three times the Gross National Product of the United States. In the middle of that century, the value of all financial assets in the US was around double that country's GNP. Since Gross National Product is a flow, and the value of financial assets is a stock, we should, strictly speaking, compare the value of financial assets against the value of some other assets (for example, the capital stock of the economy). But there are problems with measuring such stocks accurately. Financial inflation may nevertheless be observed when credit expands more rapidly than output, or when prices of financial securities rise more rapidly that prices of real output (consumption or investment goods) or wages.