Economics - the Federal Reserve

...

capital investments are known as “mal-investments.” Mises states that, “in a period of depressions a very low rate of interest- considered from the arithmetical point of view does not succeed in stimulating economic activity. The cash reserves of individuals and of banks grow, liquid funds accumulate, [excess reserves grown enormous] yet the depression continues.” Banks issue fiduciary media which are banknotes without gold backing or current accounts. Fiduciary media can expand credit and create new money in circulation, and this credit expansion lowers the market rate of interest below the original rate and stimulates economic activity through mal-investments, which otherwise would not have been purchased. Banks need to stop producing fiduciary media in order to fix this problem.

4. The Austrian element of the trade cycle is the capital theory. Investment in capital goods now is aimed at consumption later. Austrian theory shows the time element by showing what happens when the economy’s production time, or the degree of roundaboutness, is thrown out of coordination with consumer desires and by policies of government and central bank that override the market process. Mises shows how an artificially low rate of interest misallocates capital, making the production process too time-consuming in relation to the pattern of consumer demand. Time eventually reveals the discrepancy, and both markets for capital goods and consumer goods react to try and undo the misallocation. Increasing the degree of roundaboutness in response to a decrease in the market rate of interest caused by the Fed lengthens the structure of production both economically and in time as well. This causes the date when consumer goods are sold to be farther in the future than it would it would have otherwise been. It is important to understand the span of time from investment to final consumers goods is the span of time that is lengthened or shortened by the change in the structure of production caused by the alteration in market interest rates. The market works, but production takes time. As the economy becomes more capital intensive, the time element takes on greater significance. Banks cannot artificially reduce the market interest rate below the natural interest rate because this causes the production to go out of whack. Disequilibrium in the intertemporal structure of production means that some of the capital goods in some structures of production do not fit perfectly into the structure. This means there are errors in the design of consumer goods being produced and errors in the time-structure of manufacturing processes. Consumer goods do not form a pattern that makes sense.