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

774 Money, Bank Credit, and Economic Cycleswhich are often confused in theoretical discussion and analysis.Deflation refers to either an absolute decrease or contractionin the money supply or to the result such a contractiongenerally (but not always) tends to produce, i.e., a rise in thepurchasing power of the monetary unit, or in other words, afall in the general price “level.” The proposed system of a puregold standard and a 100-percent reserve requirement wouldobviously be completely inelastic with respect to contractions,and therefore would prevent any deflation understood as a decreasein the money supply, something the present “flexible monetary system”cannot guarantee, as economic crises repeatedly remind us. 76If by “deflation” we understand a drop in the general pricelevel or a rise in the purchasing power of the monetary unit, itis clear that to the extent that general economic productivityincreased faster than the money supply, such “deflation”would be present in the monetary system we recommend. Wedescribed this model of economic development above, and itoffers the great advantage of not only preventing economiccrises and recessions, but also spreading the benefits of economicdevelopment to all citizens by stimulating gradual,continuous growth in the purchasing power of each person’smonetary units and a parallel decrease in each person’sdemand for money.We must recognize that the proposed system would notguarantee a monetary unit of unchanging purchasing power.This is an unattainable goal, and even if it were achieved, itwould present no other advantage than to eliminate the premiumwhich is included in the interest rate depending on the76 After the stock market crash of October 1987, a credit squeeze waskept at bay only momentarily by the massive doses of liquidity all centralbanks injected into the system. Even so, in the economic recessionthat followed (1990–1991), central bankers were helpless to convinceeconomic agents to borrow new money, even when interest rates wereset at historically low levels (2–3 percent in the United States). Morerecently (2001), Japanese monetary authorities lowered the interest ratein that country to 0.15 percent, without provoking the expansionaryeffects predicted. Later, history repeated itself again after the stock marketcrash of 2001–2002 and the fixing of the rate of interest at 1 percentby the Federal Reserve. And again it was fixed at the historical low levelof 0–0.25 percent at the end of 2008 as a desperate reaction to the worldwidefinancial crisis.