According to the Austrian School of Economics, government-controlled central banks (i.e. The Federal Reserve) trigger cycles of boom and bust by artificially increasing the money supply (inflation).
Here’s how it works: People with money left over after they’ve satisfied their basic needs and wants (investors) put it in a bank, which then lends it out to other individuals and/or businesses for a certain price (interest rate). The interest rate not only acts as an incentive to save, it also sets an upper limit on how much borrowers can afford to borrow.
But when the Federal Reserve decides to pump money into the economy, the interest rate automatically goes down (law of supply and demand), and two things happen: People stop saving as much, because their reward for deferred gratification is not as high as it used to be, and early borrowers ramp up production (of new homes, as just one example) because the risk for them has suddenly gone down.
The whole thing comes to a screeching halt when demand inevitably fails to keep up with what is essentially an artificially-induced supply of money. With too-high inventories and maxed-out buyers, companies start laying off workers. If it gets bad enough, the stock market falls and massive unemployment follows – dampening demand for goods and services even more and deepening the downward spiral.
At this point, if the government learned its lesson from the last Great Depression, it would resist doing further damage – which is exactly the opposite of what it will wind up doing.
As economist Mark Thornton noted in 2004:
“Austrians view market crashes and depressions as the correction mechanism for the investment and organizational errors of the previous boom. In the Austrian view, the ‘correction’ should be allowed to run its course and should not be hampered by easy money policies, fiscal policy stimulus, or regulations on trade or employment….”
“The government’s attempts to save banks, maintain employment, and keep prices high is the primary reason why the [1929] crash resulted in a depression that was so severe and long lasting.”
So government interference in the market not only causes recessions, it extends them into depressions by trying to preserve the status quo – essentially undermining the necessary market correction that eliminates the unproductive (i.e. Big Three automakers) and redirects now scarce capital to more efficient uses.
But government officials never learn this lesson. Neither do most Americans, who demand that government “fix” what it just broke. So expect the litany of bad economic news to continue, but please don’t blame capitalism for this debacle.
