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

790 Money, Bank Credit, and Economic Cyclesto the present time. The central bank holds a monopoly on theissuance of currency and at any given time determines thetotal amount of the monetary base and the rediscount rateswhich apply to private banks. Private banks operate with afractional reserve and expand credit without the backing ofreal saving. They do so based on a bank multiplier which regulatesgrowth in fiduciary media and is established by thecentral bank. Thus the central bank orchestrates credit expansionand increases the money supply via open-market purchases(which go toward the partial or complete monetizationof the national debt). In addition it instructs banks as tothe strictness of the credit terms they should offer. This stageis characterized by the independence of the different countrieswith respect to monetary policy (monetary nationalism),in a more or less chaotic international environment of flexibleexchange rates which are often used as a powerful competitiveweapon in international trade. This system gives rise togreat, inflationary credit expansion which distorts the productivestructure and repeatedly provokes stock-marketbooms and unsustainable economic growth, followed bysevere economic crises and recessions that tend to spread tothe rest of the world.In the second stage the reform process advances a bit in theright direction. The central bank is legally made “independent”of the government, and an attempt is made to come upwith a monetary rule (generally an intermediate one) to reflectthe monetary-policy goal of the central bank. This goal is usuallyexpressed in terms of a rate of monetary growth exceedingthe rise in productivity (between 4 and 6 percent). Thismodel was developed by the Bundesbank of the FederalRepublic of Germany and has influenced the rule followed bythe European Central Bank and other central banks throughoutthe world. This system fosters an increase in internationalcooperation among different central banks and promotes,even in large geographical areas, where economic and tradinguniformity is greater, the establishment of a system of fixed(but in some cases revisable) exchange rates to end the competitiveanarchy typical of the chaotic environment of flexibleexchange rates. As a result, credit expansion becomes moremoderate, though it does not completely disappear, and hence