Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

Bank Credit Expansion and Its Effects on the Economic System 349The “lengthening” of the productive structure derivesfrom the fact that the only way banks can introduce into theeconomy the new money they create from nothing and grantas loans is by temporarily and artificially reducing the interestrate in the credit market and by easing the rest of the economicand contractual conditions they insist on when grantingloans to their customers. This lowering of the interestrate in the credit market does not necessarily manifest itselfas a decrease in absolute terms. Instead a decrease in relativeterms, i.e., in relation to the interest rate which wouldhave predominated in the market in the absence of creditexpansion, is sufficient. 64 Hence the reduction is even compatiblewith an increase in the interest rate in nominal terms, ifthe rate climbs less than it would have in an environmentwithout credit expansion (for instance, if credit expansioncoincides with a generalized drop in the purchasing power ofmoney). Likewise such a reduction is compatible with adecline in the interest rate, if the rate falls even more than itwould have had there been no credit expansion (for example,in a process in which, in contrast, the purchasing power ofmoney is growing). Therefore this lowering of the interest rateis a fact accounted for by theory, and one it will be necessaryto interpret historically while considering the circumstancesparticular to each case.The relative reduction credit expansion causes in the interestrate boosts the present value of capital goods, since theflow of rents they are expected to produce increases in valuewhen discounted using a lower market rate of interest. Inaddition, the lowering of the interest rate gives the appearance64 It does not matter whether this drop in the gross market rateexpresses itself in an arithmetical drop in the percentage stipulatedin the loan contracts. It could happen that the nominalinterest rates remain unchanged and that the expansion manifestsitself in the fact that at these rates loans are negotiatedwhich would not have been made before on account of theheight of the entrepreneurial component to be included. Suchan outcome too amounts to a drop in gross market rates andbrings about the same consequences. (Mises, Human Action,p. 552)