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

450 Money, Bank Credit, and Economic Cycles(c) The third type of deflation we will consider resultsfrom the tightening of credit which normally occurs inthe crisis and recession stage that follows all creditexpansion. This process was mentioned in chapters 4and 5, where we analyzed the following: just as creditexpansion increases the quantity of money in circulation,the massive repayment of loans and the loss ofvalue on the assets side of banks’ balance sheets, bothcaused by the crisis, trigger an inevitable, cumulativeprocess of credit tightening which reduces the quantityof money in circulation and thus generates deflation.This third type of deflation arises when, as thecrisis is emerging, not only does credit expansion stopincreasing, but there is actually a credit squeeze andthus, deflation, or a drop in the money supply, orquantity of money in circulation. Nevertheless thissort of deflation differs from that analyzed in (a)above and produces various positive effects whichmerit our attention. First, deflation caused by thetightening of credit does not give rise to the unnecessarymaladjustments referred to in section (a); insteadit facilitates and accelerates the liquidation of theinvestment projects launched in error during theexpansionary phase. Therefore it is the natural marketreaction necessary for a rapid liquidation of theinvestment projects undertaken in error during theexpansionary stage. A second positive effect of creditdeflation is that it in a sense reverses the redistributionof income which took place in the expansionarystage of the inflationary boom. In fact inflationaryexpansion tended to bring about a decrease in thepurchasing power of money, which in turn reducedthe real income of everyone on a fixed income (savers,widows, orphans, pensioners) in favor of those whofirst received the loans of the banking system and firstprocesses—increased cash holding of some people andincreased capital accumulation—take place side by side.(Mises, Human Action, pp. 521–22)