The Greatest Risk to an Economy – Inflation?

Readers Question: To what extent do you agree that “the greatest risk to the economy is not inflation, but over-investment

To be honest, the idea of over-investment has never struck me as being the biggest risk to an economy.

Over-investment may refer to excessive growth in an economy, such as China is experiencing at the moment. It is possible that the main problem of over investment is that inflation will occur. e.g. China is currently expanding very rapidly causing a boom and rise in inflationary pressures. Another problem of the Chinese situation is that a lot of the investment is based on bad loans. The banking sector have a poor record of lending to viable business options. Therefore, the banking sector is risking being left with bad debts related to the increase investment.

You could argue that the recent situation in America has seen an over investment in the building of new houses. The boom in house prices encouraged people to build new houses. But, when house prices started to fall, there was suddenly a glut of houses and this exacerbated the fall in prices and could cause a recession in the US.

Another problem of ‘over investment’ is that it may curtail current spending and lead to lower living standards in the short term.

However, investment is typically seen as a good thing because it enables an increase in AS (productive capacity) and an increase in AD. Investment tends to lead to higher economic growth, if it is used wisely.

Also don’t forget the costs of inflation