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

Additional Considerations on the Theory of the Business Cycle 495was an unprecedented phenomenon: an acute depressionaccompanied by high rates of inflation and unemployment. 103The crisis of the late seventies belongs to recent economichistory and we will not discuss it at length. Suffice it to saythat the necessary worldwide adjustment was quite costly.Perhaps after this bitter experience, with the recovery underway,western financial and economic authorities could havebeen required to take the precautionary measures necessary toavoid a future widespread expansion of credit and thus, afuture recession. Unfortunately this was not the case, anddespite all of the effort and costs involved in the realignmentof western economies following the crisis of the late seventies,the second half of the eighties saw the beginnings of anothersignificant credit expansion which started in the United States103 In an article in which he examines data from the crises between 1961and 1987, Milton Friedman states that he sees no correlation betweenthe amount of expansion and the subsequent contraction and concludesthat these results “would cast grave doubt on those theories that see asthe source of a deep depression the excesses of the prior expansion (theMises cycle theory is a clear example).” See Milton Friedman, “The‘Plucking Model’ of Business Fluctuations Revisited,” Economic Inquiry31 (April 1993): 171–77 (the above excerpt appears on p. 172). NeverthelessFriedman’s interpretation of the facts and their relationship tothe Austrian theory is incorrect for the following reasons: (a) As anindicator of the cycle’s evolution, Friedman uses GDP magnitudes,which as we know conceal nearly half of the total gross national output,which includes the value of intermediate products and is the measurewhich most varies throughout the cycle; (b) The Austrian theory of thecycle establishes a correlation between credit expansion, microeconomicmalinvestment and recession, not between economic expansionand recession, both of which are measured by an aggregate (GDP) thatconceals what is really happening; (c) Friedman considers a very brieftime period (1961–1987), during which any sign of recession was metwith energetic expansionary policies which made subsequent recessionsshort, except in the two cases mentioned in the text (the crisis of the lateseventies and early nineties), in which the economy entered the trap ofstagflation. Thanks to Mark Skousen for supplying his interesting privatecorrespondence with Milton Friedman on this topic. See also the demonstrationof the perfect compatibility between Friedman’s aggregate dataand the Austrian theory of business cycles, in Garrison, Time and Money,pp. 222–35.