I’m on my way through the home study course in Austrian Economics.
One thing I’ve heard Mises write about is that an expansion of credit leads to lower interest rates. Maybe I’m not far enough along in my economic studies, because this might be an elementary situation. But, how does an expansion of credit make interest rates lower, as apposed to lowered interest rates leading to an expansion of credit?
Thank you,
Cole
Someone might have a great technical answer, but there is a difference between an interest rate (price) and credit supply (inventory).
You have to increase inventory in order to drive rates down, that is to make credit or capital less scarce, thereby reducing it’s market price.
Lower interest rates (price fixing) on it’s own could cause people to stop accumulating capital as savings, and encourage release for investment but when you already have a low interest rate, and presumedly capital has already been taken from savings and moved into investment, leaving inventories low, then you will have to increase inventory to keep the artificial boom going.
Think of interest rates as the supply & demand for savings. If I want to borrow money then I should be borrowing someone else’s savings from a bank. If there aren’t enough savings, but demand for borrowing is high, then interest rates rise. This gets people to want to save more (to earn more interest on their deposits) while it deters people from wanting to borrow (because it’s expensive). The interest rate creates a balance point - an equilibrium - between the supply & demand for savings.
Now, if you want to borrow money from a bank and there aren’t enough savings then interest rates should rise. But if the bank can create money out of thin air and lend it to you then interest rates don’t have to rise. The supply of money (demanded by you) was met by creating it out of thin air.
If the bank has an asset like a bond, the Federal reserve can create money out of thin air and buy the bond from the bank. THen in the bank’s account (at the Federal Reserve) the bank gets say $1000 cash from the Fed. This is new money. The Bank can then lend 90% of this money ($900) to you. You spend it to buy a car. The seller of the car receives the $900 and puts it in his bank account. THen the bank can lend out 90% of the sellers deposit, a new loan of $810. Bob borrows the $810 and buys a stereo. The stereo seller deposits the $810 in his bank account and the bank can then lend out $729 of that balance. This is how fractional reserve banking works. The credit scheme continues until the loanable balance (From depositors) creates a total of $9000 in new credit/debt - all from the initial creation of $1000 by the Federal Reserve. The interest rate didn’t have to rise because the demand for loans was met by money created out of thin air. This is referred to the expansion of credit. $9000 in credit/debt was created / expanded out of thin air.
When you hear about the Fed and the FOMC activities to adjust interest rates, they’re talking about the Fed buying & selling US treasury bonds from the open market do do just this. Create money to regulate the interest rates at their target level.
Makes sense.
Basically, the Fed can keep interest rates low, making the demand high, and continuously create new credit. If it were to stop creating credit, there would not be enough supply to feed the demand, and interest rates would need to increase to decrease demand.
Am I thinking of this in the correct way? And, I’m assuming the home study course will explain this as I go along.
Thanks,
Cole
Cole, how is the course. I’ve been thinking about getting it. How would you rate it?
The home study course is great so far. I’ve gotten through only 4 weeks worth of readings and lectures. It starts out with the Austrian School’s history, and then right into the meat and potatoes. The review questions are quite challenging, so far, I believe. But, overall, if you have the money, it is definitely worth the effort. Learning the Austrian view of economics is very appealing when you have a nice guide to help you out. It will also help anyone build their economic and political arguments on a firm grounding.
Right.
If they lowered rates and did not increase credit, then it would stall out the economy because there would be no incentive to save and no savings to spend.
Which way does the demand curve slope?