Austrian Business Cycle

A good read about the cycle which Ron Paul and Peter Schiff kept talking about during the Republican campaign. Icelanders should be familiar with the patient’s vital signs: 

According to the theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities.

This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if the money supply remained stable. A correction or “credit crunch” – commonly called a “recession” or “bust” – occurs when credit creation cannot be sustained.

Then the money supply suddenly and sharply contracts when markets finally “clear”, causing resources to be reallocated back towards more efficient uses. 

About the Austrian Business Cycle

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