How do inflation booms affect long term growth?

Investments won't contribute to an economy's long-term growth if they are the result of unsustainable money inflation, and what's worse, they could drag down fundamentally sound businesses in the process.

Bob Gathany/AP/The Huntsville Times/File
People help assemble helium balloons for John Ninomiya, to connect to using a harness, during the Alabama Jubilee Hot Air Balloon Classic in Decatur, Ala in this file photo. Karlsson argues that investments made as a result of monetary inflation could ultimately hurt an economy more than help it.

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 research 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.

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