Initially, the artificial lowering of the interest rate creates an illusion of richness and affluence. The increase in the money stock via bank credit expansion erroneously suggests that the supply of savings increases. Investment picks up, and the economy expands. The illusion of plentiful resources leads to malinvestment, and sooner or later the boom turns into a bust. While the money-fueled expansion is a manifestation of the crisis, it is actually the slump — the correction of malinvestment — that people complain about.
He uses a wonderful quote from Mises that perfectly encapsulates the argument of those like Desmond Lachman who believe the Fed can cure a problem created by the Fed:
"In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils inflation and credit expansion have brought about."
As I stated in my debate with Lachman, my fear is the response of a government that can no longer create more inflation to cure the last credit inflation:
Inflation is a societal evil. It redistributes real wealth from creditors to debtors. It impairs the role of money as a means of exchange. The efficiency of the market's price mechanism is greatly reduced, encouraging bad decisions, which in turn harm peoples' economic well-being. At the end of the day, inflation is a serious threat to freedom. The majority of the people, suffering badly from inflation, would most likely blame the free market for their plight, rather than blame the central bank for the debasing of the currency.
From the Austrian viewpoint, the current credit crisis appears to be a precursor of great inflation. If a deliberate policy of great inflation is chosen in the United States, a monetary policy of debasing the currency would most likely also take hold in other currency areas of the world. The credit crisis has become a threat to the free societal order: as people become dispirited with the free market order, the door would be pushed open for anti–free market policies.
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