People worry about the cost of healthcare, which takes up a fair amount of the national pocketbook. This is particularly true in the United States, where we feel we are paying more than we should, based on the cost of healthcare in other civilized nations.
My question is, to what extent can inflation explain rising healthcare costs?
Note, inflation does not result from rising prices. Inflation is one cause, among several, that can cause some prices to increase.
Here, we are using a narrow definition of “inflation.” Specifically, an increase in the money supply. An increase in the supply of money doesn’t always cause an increase in prices. But, all other things being equal, it should.
We can think of any number of reasons why the cost of a good or service might rise:
- “Cost-push.” Sometimes, when the cost of production increases, the selling price can also increase. This only happens if you have a captive customer, one who has no options. So you see cost push in the price of gasoline, or in the price of airline tickets, which track the price of oil closely. You can also see it in government-granted monopolies, like the cable company or the power company.
- Insufficient production to meet demand. In this case, consumers may bid up the price of the product. This only happens if there are significant entry barriers, for example if the government restricts entry, or if it’s difficult to acquire the expertise to manufacture a product or provide a service.
- Increase in demand relative to rate of production.
In the third case, we tend to think in terms of people. When a lot of people want something that has a fixed rate of production, prices go up. But in order to account for changes in the money supply, and how quickly the supply is turning over, it’s more helpful to think in terms of how many dollars are chasing around a limited amount of goods and services. Consumers increase the number of dollars chasing a product via several mechanisms:
- By spending money, rather than saving it.
- By foregoing purchases of other products to get the stuff they want.
- By taking out a loan.
The first two don’t increase the supply of money, they just move it from one place to another. Loans, however, do increase the supply of money.
Let’s say you go to the bank and deposit $25,000 in your checking account. If you think the bank is going to hold on to that money until you ask for it, you’re dreaming. They are going to lend it out as soon as you walk out the door.
Lending money involves little more than the bank opening up a new checking account for the borrower, and then crediting that account with, say, $25,000. Thus, your bank started the day with one checking account, containing $25,000 that you can spend. And ended the day with two checking accounts, totaling $50,000, including 25K the other guy can spend. That’s the guy who is going to bid against you when you go to buy a car.
Where did the $25K come from, for the other guy’s loan? It came out of nowhere, essentially. The bank just made it up. That’s where new money comes from. To be clear, the bank has to make good on it eventually. They have to hope Player 2 makes loan payments at a fast enough rate to accommodate Player 1 when he wants to make a withdrawal, plus skim a bit of money off the top for profit. Still. That bank has increased the number of dollars chasing cars in your market. You can expect the price of cars to be bid up as a result.
Note how inflationary price increases — those due to an increase in the money supply — can’t possibly affect all prices at once. They can only affect things people borrow money to buy.
We are pretty sure we are seeing inflation in the stock market right now, and have been for a few years (Bernanke admitted as much during congressional testimony). We have seen several bouts of inflation in the housing market, one of which crashed spectacularly in 2008.
This leads people to think that inflation is primarily a monetary phenomenon, that it’s all engineered by the banking system, with the Fed at the top of the pyramid. And that’s true to a certain extent; certainly the Fed believes that it is true, as it has inflation targets it’s trying to hit.
The question is, can fiscal policy result in inflation? Can the US Government inflate the price of a good or service?
The government borrows a lot of money, and then spends it. What’s it spending that money on? I’ll bet we can find examples of government-sponsored inflation, and I’ll bet healthcare is one.
Next up, Part 2: The Bennett Effect.