Schweser notes book2, P186, 2nd last paragraph, it says uncertainty about inflation also tends to decrease saving and investment since greater uncertainty about future returns increase the risk of saving and investment compared to current consumption. In either case, a decrease in savings and investment slows the growth rate of country’s capital stock, which reduces potential real GDP. --I agree with there is less saving and investment under uncertain inflation; and people try to spend more money currently. However, all the consumptions go to AD, more consumption generates more GDP. Why it says reduces potential real GDP?
I would think that the current consumption would increase AD but only increase short-run GDP above long-run GDP. But eventually the long-run GDP would not increase as a result of the current consumption, but decrease due to reduced savings and investments as a cause of inflation. This is how I think it would be. Maybe I’m right. If someone else could confirm, that would be great. Hope it helps.
my guess is that near term consumption does not have nearly the multiplying effect that savings and investments have to the economy.
Very good question. I googled and found this: http://www.investopedia.com/articles/06/gdpinflation.asp GDP is reported after subtracting inflation. So even if the spending increases, a high inflation will cause a net decrease in GDP.
I guess this is a stagflation. price goes up, unemployment rate is high, and real GDP goes down.
This is my understanding of the concept.Potential GDP is the highest possible GDP given a Country’s mix of production factors.Since Capital is one of the Key compnents of production, an increase in it’s value will increase the potential GDP.An increase in Consumption will incease AD and GDP in the Short term as firms respond to increased Demand but will not increase the highest possible level of Production(potential GDP).