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

Bank Credit Expansion and Its Effects on the Economic System 373detail in 1937. 82 Hayek demonstrated that the processof investment in capital goods generates anautonomous demand for subsequent capital goods,precisely ones which are complementary to thosealready produced. Furthermore this phenomenon willlast as long as the belief that the production processescan be completed. Thus entrepreneurs will rush todemand new loans regardless of their cost, beforebeing forced to admit their failure and altogether abandoninvestment projects in which they have allocatedvery important resources and with respect to whichthey have jeopardized their prestige. As a result, thegrowth in the interest rate which takes place in thecredit market at the end of the boom is not only due tomonetary phenomena, as Hayek had previouslythought, but also to real factors that affect the demandfor new loans. 83 In short, entrepreneurs, determinedto complete the new capital goods stages they have82 See F.A. Hayek, “Investment that Raises the Demand for Capital,”published in Review of Economics and Statistics 19, no. 4 (November 1937)and reprinted in Profits, Interest and Investment, pp. 73–82.83 Hayek himself, in reference to the rise in interest rates in the finalstage of the boom, indicates that:[T]he most important cause practically of such false expectationsprobably is a temporary increase in the supply of suchfunds through credit expansion at a rate which cannot bemaintained. In this case, the increased quantity of currentinvestment will induce people to expect investment to continueat a similar rate for some time, and in consequence toinvest now in a form which requires for its successful completionfurther investment at a similar rate. . . . And thegreater the amount of investment which has already beenmade compared with that which is still required to utilise theequipment already in existence, the greater will be the rate ofinterest which can advantageously be borne in raising capitalfor these investments completing the chain. (Hayek, “Investmentthat Raises the Demand for Capital,” pp. 76 and 80)Mises points out the boom ends precisely when the entrepreneurs beginto experience difficulties in obtaining the increasing amount of financingthey need for their investment projects: