Covenants p.65 Inflation adresses the typical erosion of the value of trade goods, of which the covenant pushes lots into the local market. For this to happen, no silver coinage needs to be involved at all, but just some market glut.
The chapter makes clear, that it does not provide economical modeling, but just a rule of thumb for quick evaluation. If you like to detail the economy around your covenant any better, you are welcome to your homework.
Realistically the inflation should have a limit, and should probably be modeled on a decrease in income rather than an increase in costs. The depreciation due to a new good being produced tends to have a fairly low ceiling, especially in the case of effectively a land management situation where someone else was likely already producing the same good prior to your involvement.
Realistically what it provides is an incentive for the magi to have ongoing concerns about the management of their covenant as costs rise and income has the potential to drop.
Covenants p.63 Inflation addresses local spending of a covenant at a value of a hundred pounds silver or more per year. Taking over existing local productions of such value tends to be a kind of revolution, like ousting some baronets. This risks labeling as 'mundane interference' at Tribunal, and is not typical for the founding of a covenant. It is possible, though, with solid mundane and Hermetic preparation: Triamore (GotF p.47) is an example.
There are many other kinds of covenants. Oculus Septentrionalis (GotF p.70ff), whose magi act economically on a supra-regional or even European scale, is certainly not affected by the Covenants p.63 Inflation rule of thumb. These magi need to coexist with the other merchants and the Dominion of Lübeck instead.
EDIT: If a covenant has a companion who is a capable merchant and regional trader, this companion may prevent local market glut for covenant products. He will also have to recover hauling expenses, and wish to make a little extra profit off the top.
To that degree, establishing a new covenant anywhere and generating income could be seen as interference with mundanes. The fact is that the economics in Ars Magica is extremely unrealistic, both in terms of how actual medieval economies operated and in term of the simple math where frequently a craftsperson makes more money manufacturing then the items they can make in that time period sell for.
That depends - among other things - on where the covenant is established, and which mundanes' income it takes away.
'Interference with mundanes' is arbitrated by the Tribunal, and persecuted if it looks like it might cause trouble. Usurping the income of some minor nobles requires significant work by the would-be covenant founders, to assure that neither nobility nor sodales feel threatened.
E. g. ArM4(!) Triamore has a very complex backstory, before it arrives at its state in 1220: warily watched by the Quaesitores and the count of Namur, but not marched or besieged.
Remember, inflation in Ars Magica is an abstraction. Magi have the potential to achieve dramatic and sudden increases in productivity in certain areas, and due to the greedy nature of magi, this is often quickly accompanied by increases in costs within the covenant... Which in some cases leads to more sudden increases in some area's productivity, because that's how magi roll, but generally just means pulling in a lot more of some resource. Suddenly they've added a lot of extra grain to the economy and pulled an equally enormous amount of iron from the local mines. Grain prices go down, reducing the impact of the aforementioned increased grain productivity, while iron prices skyrocket. People still need iron and iron tools, and now that those are more expensive, they have to make everything else they produce a little more expensive so they can afford the iron and tools they need.
Again, it's really simplified, but remember, this is also measuring very gradual long-term price trends, not the normal month to month fluctuation in the value of a given good. In-game inflation is measured, and changes, in terms of years.
A covenant, that introduces new products with a value of over 100 pounds of silver per year to a local medieval economy, needs quite some time and effort to become established as a normal part of that economy.
Covenants p.65 Inflation provides a simple rule of thumb for the price of not making that effort, if you do not wish to make it a part of the saga to be played out in more detail.
If your covenant already exists for a century or two, and you decide that in its past it already made the needed effort to 'fit in' economically, you can also disregard that chapter.
Okay, now someone explain to me why the covenant's revenue does not increase proportionally with the rising inflation - because it should. Everyone is paying more for everything because they have more money - this should also apply to the goods the magi are selling, right?
Inflation isn't something that should affect covenant finances. It's background noise, a flux in the amount of actual silver that a Mythic Pound represents.
I think the basic idea is that, however you obtain your 1000 Mythic pounds per year -- even if they are, say, 1000 Mythic Pounds in onions rather than in silver -- when you try to spend them/ barter them away to obtain other goods, you are creating a lot more competition for those other goods then there was before. So, whatever goods you try to extract from the local economy, those goods become more expensive for you.
I do agree it's really a rather clumsy mechanic, and the fact that it's "simple" is no real justification for its clumsiness, since it could have been made just as simple but far less clumsy. As an example of its clumsiness, consider a covenant with a Great (250 pounds/year) source of revenue. It's just a minor boon, and not that much compared to what some powerful lords or merchant clans earn. After 60 years, the covenant suffers a magical accident that cuts it off from the outside world - it stops spending any money for food, salaries etc. But its costs stay way up and keep rising! Because it has accumulated 60x2 = 120 pounds of inflation over those 60 years, so it needs to spend 120 pounds/year just to cover that, and that creates even more inflation!
Sure, you can handwave it away as a rule. But then, why bother to write it up? It's not as if the Covenant's finances rules can't be assumed to already cover it.
What I would have done instead would have been to put in place a new Hook that basically says:
"Due to your remote location and/or insufficient access to trade networks, you can only spend freely a quarter (25%) of your income every year. Spending more in a given year is possible, but requires a story that either explains how you managed to trade away your surplus/obtain the expensive goods you are seeking, or has you deal with the negative consequences of the covenant's spending on the local economy".
Covenants p.65 Inflation addresses not only the silver coinage inflation caused by spending lots of silver in a local medieval economy, but also the "corrosive effects" caused by unloading lots of goods into it.
So the title of this chapter is not encompassing all its content: it might have been chosen for brevity, and because silver inflation was foremost on the author's mind.
Also, applying "a rule of thumb" (see en.wikipedia.org/wiki/Rule_of_thumb ) always requires common sense and an eye towards concrete situations - be it in engineering, economy or role playing games. Blindly following a role player's instinct and parsing it in a contrived situation is misunderstanding its purpose.
The real question is how long it takes for a covenant to become an established part of the economy and how it started generating wealth, and how long that took. If the Magi show up, grab some nearby land (why wasn't anyone else using it) and starts churning out magically created goods at little expense then the inflationary impact should be immense. Generally, however, establishing yourself to where you can make the kind of income a covenant is making takes some time...
I didn't want to get into the economics discussion but can't help but point out that producing and marketing more goods, all else being equal, should lower prices. That's deflationary, not inflationary.
A Covenant would generate inflationary pressure if it started consuming inordinate amounts of local goods. Unless the Covenant is as big as a large castle or small town, I don't think that's likely. Extremely expense lab equipment and luxuries are probably going to be purchased through long distance trade and not affect local prices at all.
The goods are not your money of account though, mythic pounds are in AM5. A surplus of trade goods will reduce the value of said goods against mythic pounds, not increase the mythic pound cost of other goods and services.
Mythic pounds are an abstract, not a money of account, and most places in mythic Europe (aside from Italy) you will not have money of account, only bartered goods and occasional currency.
As such if our covenant is producing wool, and trading that for goods, and all other goods begin to require more wool in order to purchase them, then for the purposes of our covenant wool is money, which is loosing value. To everyone else in the area of course wool is a good (except fellow shepherds) which is falling in price.
The inflation rules are obviously discretionary (in that they will not always apply), but if the rule of thumb is used, a covenant is forced to improve their income continuously to maintain (not improve) a standard of living. Over the lifetime of a magus (100 years), a covenant that starts spending 100 pounds per annum will need well over 300 pounds at the end (if you round upwards), just to keep the same standard of living.
This is IMO a rather large problem, and it's one that strikes immediately. If a covenant is spending its income (rather than living below its means), it runs into a cash crisis right away. The 'standard' 4 magi spring covenant can easily spend 100 pounds a year without really trying*, so the default setting is not a tenable situation, and that's a problem.
*You generally have to employ a lot of the cash saving options in Covenants to make it work on less than 100 pounds.
100 pounds causing inflation seems to be based on assumptions that might not be valid in more populous areas. I'm pretty sure that's going to be a drop in the bucket someplace like Merv or Baghdad (both with populations estimated at around one million before the Mongols show up).
I suspect the idea of inflation as a long-term and inexorable erosion of living standards is linked to political ideas about inflation in circulation in 2006. When much of the developed world is both printing money and running negative interest rates -- and not generating inflation -- such views seem somewhat out of place.
My best advice, simply drop the inflation and annual fluctuation rules and only change covenant finances based on a story.