Inflationary Booms & Long Term Growth

There was another thing in the The Economist article that I wrote about yesterday that I think I should comment on, namely this:

But when growth picks up, investment recovers and along with it the capital stock. Mr Thoma says policy makers should not hold back on stimulative policies for fear of hitting a short-run supply ceiling, since that ceiling will rise as demand and investment pick up.

It is true that a higher level of investment will, assuming the investments are sound, increase long term growth and it is also true that this factor will limit the effect on price inflation that monetary inflation has.

However, investments that are the result of unsustainable monetary inflation will not increase long term growth as they will be revealed to be malinvestments during the following slumps. And what's worse, the slumps that follows often tends to drag down some businesses that are fundamentally sound, while many workers lose skills (and fails to get more useful skills that they might have gotten) in more useful industries.

But isn't it possible that some investments in reasearch and development that are financed by inflationary credit could boost output permanently? Well, yes that is possible, just like it is possible that if you gave all unemployed workers $200,000 each to start businesses then some of those businesses could become success stories. But it is highly unlikely that these successes will become common enough to compensate for the damage done to other businesses and workers during slumps and the high cost for the government respectively.