Boom-Bust Cycles and Easy Money

Boom-Bust Cycles and Easy Money by  – Mises

Only a few months ago most economic commentators were sanguine about prospects for the US economy. Most of them did not expect an imminent downturn. Now all that has changed with most experts expecting the economy to enter a downward phase of the economic cycle by 2019. According to experts, the key factor behind the emerging downturn is the policies of the US President Trump in particular the imposition of tariffs on imports. Very few analysts however attribute the possible downturn to the decline in the annual growth rate of money supply. The exception here are the monetarists (i.e., the followers of Milton Friedman).

According to Friedman, the root of the business cycle is the fluctuations in the growth rate of money supply.

Friedman held that what is required for the elimination of these cycles is for central bank policy makers to aim at a fixed rate of growth of money supply:

My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specified rate of growth in the stock of money. For this purpose, I would define the stock of money as including currency outside commercial banks plus all deposits of commercial banks. I would specify that the Reserve System should see to it that the total stock of money so defined rises month by month, and indeed, so far as possible, day by day, at an annual rate of X per cent, where X is some number between 3 and 5. The precise definition of money adopted and the precise rate of growth chosen make far less difference than the definite choice of a particular definition and a particular rate of growth.1

Now if economic cycles are caused by fluctuations in money supply growth, then it makes a lot of sense to eliminate such fluctuations. In this sense, the constant money growth rate rule seems to be the right remedy to eliminate such cycles.

What sets in motion these cycles is not fluctuations in the growth rate of money supply as such, but the fluctuations in the growth rate of money supply generated out of “thin air.” By money “out of thin air,” we mean money that is created by the central bank and amplified by fractional reserve lending by commercial banks.

An increase in the money supply out of “thin air” provides a platform for non-productive activities, which consume and add nothing to the pool or real wealth. Money out of “thin air” diverts real wealth from wealth generators to non-wealth generating activities, thus weakening the wealth-generating process.

The diversion occurs once various individuals that are the early receivers of this newly created money are exchanging new money for goods and services by contributing nothing to the pool of goods and services. Wealth generators that have not received this newly printed money discover that they can now secure fewer goods than before. (The increase in the prices of goods and services manifests this).

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