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

540 Money, Bank Credit, and Economic Cyclesand the appearance of expectations regarding its consequences.In any case the formation of realistic expectationsmerely speeds up the processes that trigger the crisis andmakes it necessary for new loans to be granted at a progressivelyincreasing speed, if the policy of loan creation is to continueproducing its expansionary effect. Therefore, otherthings being equal, the more accustomed economic agentsbecome to a stable institutional environment, the more damagingcredit expansion will be, and the more maladjustmentsit will cause in the stages of the production process. (This particularlyapplies to the expansion of the 1920s, which led to theGreat Depression). Moreover, ceteris paribus, as economicagents become more and more accustomed to credit expansion,larger and larger doses of it will have to be injected intothe economic system to induce a boom and avoid the reversioneffects we are familiar with. This constitutes the only elementof truth in the hypothesis of rational expectations. (In thewell-chosen words of Roger W. Garrison, it is “the kernel oftruth in the rational expectations hypothesis.” 44 ) Neverthelessthe assumptions on which the theory rests are far from beingproven right, and entrepreneurs will never be able to completelyrefrain from taking advantage of the immediate profitopportunities which arise from the newly-created money theyreceive. Thus even with “perfect” expectations, credit expansionwill always distort the productive structure. 45In short the underlying thesis behind the theory of rationalexpectations is that money is neutral, given that agents tend to44 Garrison, “What About Expectations?, p. 1.45 The crucial question devolves around the source of errors incyclical episodes. In Hayek’s analysis, misallocations anderrors occur as economic actors respond to genuine price signals.. . . Entrepreneurs are being offered a larger commandover the real resources in society; the concomitant changes inrelative prices make investing in these real resources genuinelyprofitable. There is surely nothing “irrational” in entrepreneursgrasping real profit opportunities. (O’Driscoll,“Rational Expectations, Politics and Stagflation,” in Time,Uncertainty and Disequilibrium, p. 166)