Gerry Steele in Economic Affairs on Hayek’s business cycle theory.
An easy-money policy can be veiled by many factors, which include the impact upon unit costs of new technologies and falling commodity and energy prices. Given microeconomic variations in unit costs supply and in the responsiveness of demand to subsequent price adjustments, attempts to use monetary policy, even to prevent the general level of prices from falling, have a potential to disturb real economic activity: ‘it is not changes in the value of money which should be at issue, but disturbances of the intertemporal price system which are without any economic function’ Hayek, 1928, p. 98 .. When interest rates are held down by easy money, investment is stimulated generally, but with the greatest impact upon longer-term projects. From that basis, and in looking beneath the general price level, Hayek traced the microeconomic sequences by which monetary expansion sets a business cycle in motion. In emphasising the diversity of capital investments, Hayek showed how an easy-money policy causes a mismatch between consumers’ demands and investors’ plans. Once underway, inappropriate expenditures carry the seeds of their own demise by their support of investment structures that without prior saving are unsustainable.
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