Recovery, Inflation, and Oil

Forestalling future inflation is not just a matter of investment vs. consumption; smart policies to ease recovery bottlenecks (especially oil shocks), improve competitiveness, and improve the efficiency of health care are also important.

Jonathan reiterates a useful point on biasing deficit spending toward capital investment that increases future potential output. (Even current investment that substitutes for future needed capital expenditures –for example rebuilding national parks infrastructure– that do not themselves increase potential output is better than consumption, if it can be spent out quickly enough). If inflation is a matter of too much money chasing too few goods, then enlarging the supply of goods can help.

But it’s important to be clear that smart policy and investment today can affect future output in two important ways not usually accounted for in growth theory. As suggested here previously, it is important to take the interactions among economic forces into account.

First, dynamics are important. Supply-side inflation via higher prices of inelastically supplied commodities (especially oil) is a key way recoveries are choked off. Thus the right energy policies — including policies and investments to reduce the oil intensity of our GDP — are crucial to reducing future inflationary pressures and increasing the path of future output. Such action is needed for energy security and carbon reduction reasons as well as macroeconomic management, so it’s a threefer.

Second, the composition of GDP is important. For example, much of our health care spending is the economic equivalent of empty calories– by making the health care sector provide better health to more Americans at lower cost, we free up funds for future investment and also improve the amount and productivity of our human capital. Reducing the rate of health care inflation and disconnecting health care from production costs will improve our manufacturing competitiveness, strengthening the dollar, reducing the overall inflation rate, and freeing up resources for potential-increasing investments.

Forestalling future inflation is not just a matter of investment vs. consumption; smart policies to ease recovery bottlenecks (especially oil shocks), improve competitiveness, and improve the efficiency of health care are also important.