In Part 1, I narrowly defined inflation as an increase in money supply. An increase in the number of dollars chasing a limited supply of goods and services, all other things being equal, will cause the price of those goods to be bid up. “Inflation” thus defined is historically a result of monetary debasement, although in modern times, in civilized countries, it typically comes about through expansion of credit.
Federal spending currently accounts for about a quarter of the GDP, about a third of that borrowed. The portion that is borrowed consists of newly-printed dollars, some of which are chasing targeted goods and services. Can fiscal policy thus result in inflation?
William Bennett, former secretary of education, suggested as much in a 1987 NYT editorial entitled “Our Greedy Colleges.”
If anything, increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. In 1978, subsidies became available to a greatly expanded number of students. In 1980, college tuitions began rising year after year at a rate that exceeded inflation. Federal student aid policies do not cause college price inflation, but there is little doubt that they help make it possible.
William Bennett, NYT 1987
Here, he seems to be using the term “inflation” to refer to higher prices, a phenomenon he admits is multifactorial. But there seems little doubt he hypothesizes that throwing a great deal of money at a limited supply of services has a tendency to drive prices higher.
Sense then, there have been several studies seeking to disprove his hypothesis. All have limitations. A typical study seeks to correlate volume of Pell grants with tuition, showing inconsistent results. Such studies disregard the fact that colleges have several sources of income other than Pell grants and cash-on-the-barrel tuition fees. And invariably, these studies seem ignorant of the fact that loans are, by nature, inflationary.
Personally, I would be most interested in a study like this, which compares out-of-state tuition with per-person student loan debt:
To the extent these two lines are correlated, tuition increases are being funded by debt. Which is, by definition, inflationary.
Remember, there are only three ways to bid up the price of something:
- To dip into your savings for extra cash.
- To forego buying something else.
- To borrow money.
The tight correlation between borrowing and tuition suggests that the first two things are, to a great extent, not in play. To be clear, people do save for college, and their parents do make sacrifices. But that’s not what is driving tuition inflation in recent years. (One might hypothesize that real income, and real savings have been flat during this time period; and one would not be far from the truth.)
Hold on, you might say. What about all the extra people clamoring for college education these days? Doesn’t that affect the price of tuition?
That’s partially why I am comparing per-student debt with per-student tuition; but in a larger sense, you’re right. Of course it does. But you have to understand how the system works.
As more and more people demand education, they bid up prices and profits. This encourages new entrants, people starting up their own colleges to get in on the action. This tends to hold prices and profits down. Even so, prices may rise to the point where people figure it’s not worth it, and start looking to spend their education dollars elsewhere, for example in technical school. That reduces demand, thus putting further downward pressure on prices and profits.
So, you form a cartel and first approach the government about passing laws to keep the competition out. That helps. Then you beg the government for grants. And when that goodwill runs out, you lobby for lending. And once the lending starts, you’re dealing with pure inflation.
The key is, to keep the rate of education inflation above the rate of inflation for things college administrators want to buy. And of course it’s not all about the champagne and foie gras. It’s also about buying buildings and professors and such. They do have a business to run, after all. And you’re going to pay for it, one way or another.
This is no different than saying inflation in the housing market is being driven by the mortgage debt market, or that stock values are being driven up by companies borrowing money to re-purchase their own stock.
Where you see inflation, is where you are allowed to spend borrowed money. When banks are holding the strings, they tend to approve loans for specific things, like cars and houses. We can expect those prices to be bid up when loans are readily available.
When the government is holding the strings, it will tend to promote spending with borrowed money on certain things. The government itself will borrow money to buy jet fighters and tanks, and it should come as no surprise, those things are expensive. Here, the government is encouraging people to borrow their own money for education, with predictable results.
To be clear, fiscal policy and monetary policy are working hand-in-hand. The Fed is working to keep the cost of borrowing abnormally low (in other words, has set the price of money below the market-clearing price) thus resulting in inflation. Which sectors see that inflation is a matter of policy, and that’s true regardless of who is setting that policy: the Congress, the Fed, or both.
Part 3: how this applies to healthcare