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

Bank Credit Expansion and Its Effects on the Economic System 357indicators (such as the price of present goods in terms offuture goods, or the market rate of interest), or the granting ofprivileges against traditional legal principles, spontaneouslytriggers certain processes of social interaction which, as theyare driven precisely by entrepreneurship and its capacity tocoordinate, tend to halt and rectify errors and discoordination.Great credit goes to Ludwig von Mises for being the first toreveal, in 1912, that credit expansion gives rise to booms andoptimism which sooner or later invariably subside. In his ownwords:The increased productive activity that sets in when thebanks start the policy of granting loans at less than the naturalrate of interest at first causes the prices of productiongoods to rise while the prices of consumption goods,although they rise also, do so only in a moderate degree,namely, only insofar as they are raised by the rise in wages.Thus the tendency toward a fall in the rate of interest onloans that originates in the policy of the banks is at firststrengthened. But soon a countermovement sets in: the prices ofconsumption goods rise, those of production goods fall. That is,the rate of interest on loans rises again, it again approaches thenatural rate. 7171 Mises, The Theory of Money and Credit, p. 401; italics added. The lasttwo sentences are so important that it is worthwhile to consider Ludwigvon Mises’s expression of the essential idea in his original German edition:Aber bald setzt eine rückläufige Bewegung ein: Die Preise derKonsumgüter steigen, die der Produktivgüter sinken, dasheißt der Darlehenszinsfuß steigt wieder, er nähert sichwieder dem Satze des natürlichen Kapitalzinses. (Ludwigvon Mises, Theorie des Geldes und der Umlaufsmittel, 2nd Germaned. [Munich and Leipzig: Duncker and Humblot, 1924],p. 372)Mises, who was strongly influenced by Wicksell’s doctrine of “naturalinterest,” bases his theory on the disparities which emerge throughoutthe cycle between “natural interest” and “gross interest in the credit (or‘monetary’) market.” Banks temporarily reduce the latter in theirprocess of credit expansion. Though we view Mises’s analysis as impeccable,we prefer to base our presentation of the theory of the cycle