The Austrian Theory of the Trade Cycle and Other Essays (LvMI)

by Richard M. Ebeling

Mises showed that an artificially low rate of interest, maintained by credit expansion, misallocates capital, making the production process too time-consuming in relation to the temporal pattern of consumer demand. As time eventually reveals the discrepancy, markets for both capital goods and consumer goods react to undo the misallocation. The initial misallocation and eventual reallocation constitute the microeconomic foundations that underlie the observed macroeconomic phenomenon of boom and bust. Mises’s theory was superior to its Swedish forerunner in that Wicksell was concerned almost exclusively with the effect of credit expansion on the general level of prices. It was superior to its British forerunner in that the currency school’s theory applied only when monetary expansion in one country outpaced that of its trading partners. Mises’s theory was applicable even to a closed economy and to a world economy in which all countries are experiencing a credit expansion.