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

Additional Considerations on the Theory of the Business Cycle 451experienced an increase in monetary income. Now, inthe stage of credit tightening, this forced redistributionof income reverses in favor of those who in theexpansionary stage were the first harmed, and thuspeople on a fixed income (widows, orphans, and pensioners)will gain an advantage over those who mostexploited the situation in the earlier stage. Third,credit deflation generally makes business venturesappear less profitable, since historical costs arerecorded in monetary units with less purchasingpower, and later, accounting income is recorded inmonetary units with more purchasing power. As aresult entrepreneurial profits are artificially diminishedin account books, prompting entrepreneurs tosave more and distribute less in the form of dividends(exactly the opposite of what they did in theexpansionary phase). This tendency to save is highlyfavorable to the commencement of economic recovery.49 The decline, provoked by the tightening ofcredit, in the quantity of money in circulationundoubtedly tends to drive up the purchasing powerof the monetary unit. An inevitable drop in the wagesand income of the original means of production follows,though at first this decrease will be more rapid49 An analysis of the positive effects of this third type of deflation(caused by the tightening of credit in the recession stage of the cycle) canbe found in Rothbard, Man, Economy, and State, pp. 863–71. See alsoMises, Human Action, pp. 566–70. Furthermore Mises indicates thatdespite its negative effects, the deflationary squeeze is never as damagingas credit expansion, becausecontraction produces neither malinvestment nor overconsumption.The temporary restriction in business activitiesthat it engenders may by and large be offset by the drop inconsumption on the part of the discharged wage earners andthe owners of the material factors of production the sales ofwhich drop. No protracted scars are left. When the contractioncomes to an end, the process of readjustment does notneed to make good for losses caused by capital consumption.(Mises, Human Action, p. 567)