Cyclical Changes in Business Conditions
The Role of Interest Rates
In our economic system, times of good business commonly alternate more or less regularly with times of bad business. Decline follows economic upswing, upswing follows decline, and so on. The attention of economic theory has quite understandably been greatly stimulated by this problem of cyclical changes in business conditions. In the beginning, several hypotheses were set forth, which could not stand up under critical examination. However, a theory of cyclical fluctuations was finally developed which fulfilled the demands legitimately expected from a scientific solution to the problem. This is the circulation-credit theory, usually called the monetary theory of the trade cycle. This theory is generally recognized by science. All cyclical policy measures, which are taken seriously, proceed from the reasoning which lies at the root of this theory.
According to the circulation-credit theory (monetary theory of the trade cycle), cyclical changes in business conditions stem from attempts to reduce artificially the interest rates on loans through measures of banking policy — expansion of bank credit by the issue or creation of additional fiduciary media (that is, banknotes and/or checking deposits not covered 100 percent by gold). On a market, which is not disturbed by the interference of such an “inflationist” banking policy, interest rates develop at which the means are available to carry out all the plans and enterprises that are initiated. Such unhampered market interest rates are known as “natural” or “static” interest rates. If these interest rates were adhered to, then economic development would proceed without interruption — except for the influence of natural cataclysms or political acts such as war, revolution, and the like. The fact that economic development follows a wavy pattern must be attributed to the intervention of the banks through their interest rate policy.
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