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

404 Money, Bank Credit, and Economic Cycles(c) Finally let us suppose that the banking system at notime reduces the rate at which it accelerates creditexpansion, and instead does just the opposite: it constantlyand progressively intensifies it, with the purposeof quashing any symptom of an emergingdepression. In this case, the moment economic agentsbegin to realize that the rate of inflation is certain tocontinue growing, a widespread flight toward realvalues will commence, along with an astronomicaljump in the prices of goods and services, and finally,the collapse of the monetary system, an event whichIn 1969 Hayek again used this analogy in his article, “Three Elucidationsof the Ricardo Effect,” in which he reiterates that the distortingeffect of credit expansion on the productive structure must continue aslong as banks create new money and this money enters the economicsystem at certain points at a progressively increasing rate. Hayek criticizesHicks for assuming the inflationary shock will “uniformly” affectthe entire productive structure, and he demonstrates that if creditexpansion escalates at a rate exceeding the rise in prices, this process“can evidently go on indefinitely, at least as long as we neglect changesin the manner in which expectations concerning future prices areformed.” He concludes:I find it useful to illustrate the general relationship by an analogywhich seems worth stating here, though Sir John [Hicks](in correspondence) did not find it helpful. The effect we arediscussing is rather similar to that which appears when wepour a viscous liquid, such as honey, into a vessel. There will,of course, be a tendency for it to spread to an even surface. Butif the stream hits the surface at one point, a little mound willform there from which the additional matter will slowly spreadoutward. Even after we have stopped pouring in more, it willtake some time until the even surface will be fully restored. Itwill, of course, not reach the height which the top of the moundhad reached when the inflow stopped. But as long as we pourat a constant rate, the mound will preserve its height relative tothe surrounding pool—providing a very literal illustration ofwhat I called before a fluid equilibrium. (Hayek, New Studies inPhilosophy, Politics, Economics and the History of Ideas, pp.171–73)On the important role of expectations in this entire process, see especiallyGarrison, Time and Money, chaps. 1–4.