After our talk today I realized that. The connection between inflation and the business cycle is simpler than anything I said.
1. when the money supply goes up and price inflation occurs people naturally start buying stuff because they know prices will be higher the next day, week, or month.
2. Because of the demand, not only do prices go up even more but producers put all, or most, of their effort into production of consumer goods.
3a. If the government reduces the money supply then demand and prices fall and there is a bust.
3b. If the government continues to increase the money supply and even if we grant that wages can catch up, which is very unlikely, producers will be forced to continue producing consumer goods and not investing in capital goods their productive capacity will diminish because of lack of repairs. this seems strange but remember they are competing with others in the short term to produce goods at as low of a price as possible. If they divert their resources to buy new machinery they will lose out on market share in the short term and with prices increasing they might not survive.
OK, maybe that was not so simple.
No that is simple enough, but wouldn't that mean that in a boom, productivity wouldn't increase much because the companies are always trying to keep up with consumer demand?
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