The central banks are said to be creating booms and busts, but didn’t entrepreneurs learn already that when the saving rate is low they shouldn’t be investing in long term projects? Besides in a global economy this interventiom should be mitigated to a large extent. For example let’s say the central banks created artificially low interest rates in the United States, but artificially high interest rates in Europe. So if an entrepreneur wants a loan he’d buy dollars, and if a consumer wants to save money he’d buy Euros. So according to this the market should already adapt to the stupid interventions of the central banks and negate its negative effects, isn’t is so?
This is actually a very common criticism of the Austrian business cycle theory, but is nonetheless incorrect for the following reasons:
- Once credit expansion begins, there is no way to know what the money rate of interest would be absent the increases in liquidity. The only way to discover what the market rate of interest is is to let the market adjust to it. In simpler terms, the entrepreneur is incapable of discovering which loanable funds are legitimate consumer investments and which are liquidity injections from the central bank.
- Entrepreneurs who are hesitant about taking out loans (the ones who are fluent in economics) will be pressured to be those who do, so as not to f"all behind the competition", so to speak.
- As prices are inflated as a result of the credit expansion, entrepreneurs will be forced to take advantage of the cheap loans just to keep pace with the price increases. This can be seen in the “bubble” housing market where individuals who were not interested in home speculation were required to take out massive mortgages just to buy a house to live in.
Not if central banks coordinate their actions and decide to inflate or deflate together, which is the situation we’re facing now. The Federal Reserve is very involved and interested in the actions of the Bank of Japan, and vice versa.
If the global economy were to ever face this situation, it would at best mitigate the effects of credit expansion. Distortions in the structure of production would be more localized to the United States or countries which use the USD/have their currency pegged to it. Central banks in the countries with high interest rates would most likely be pressured by local businesses to lower them to avoid having the United States’ pull ahead of them in terms of economic growth.
I hope this helped make the issue cleare for you. I’m by no means an expert, so I’m sure other forums members will be willing to chime in with more learned responses.
Double post, sorry. Feel free to delete this one.
Another thing I’d like to bring to the table, which is something I don’t hear other people say, is the matter of incorporation. If you can create a legal entity that can go bankrupt BUT it doesn’t effect the money that was paid out as salary, then staying affloat long term is not a sufficient requirement for the decision to go into business (with loans).
Also, the arbitrage will be eliminated by the market.
Yeah thank you, that was very informative.
Okay, I have another objection. When people usuall save money they don’t save it to buy something specific, they just save for a rainy day or maybe for a house somewhere in the distant future. I don’t think the stages of production are so long that they match the length of the average saving period. That is, at most I would expect a return of investment after 10 years, yet after 10 years most savers might not have started to consume, they still save.