The Role of Central Banks
Austrians generally argue that inherently damaging and ineffective central bank policies, including unsustainable expansion of bank credit through fractional reserve banking, are the predominant cause of most business cycles, as they tend to set artificial interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles", and artificially low savings. Under fiat monetary systems, a central bank creates new money when it lends to member banks, and this money is multiplied many times over through the money creation process of the private banks. This new bank-created money enters the loan market and provides a lower rate of interest than that which would prevail if the money supply were stable.
Murray Rothbard argues central banks played a large role in creating an environment of loose credit prior to the onset of the Great Depression, as well as the subsequent ineffectiveness of central bank policies, which he argues delayed necessary price adjustments and prolonged market dysfunction. Rothbard begins with the premise that in a market with no centralized monetary authority, there would be no simultaneous cluster of malinvestments or entrepreneurial errors, since astute entrepreneurs would not all make errors at the same time and would quickly take advantage of any temporary, isolated mispricing. In addition, in an open, non-centralized (uninsured) capital market, astute bankers would shy away from speculative lending and uninsured depositors would carefully monitor the balance sheets of risky financial institutions, tempering any speculative excesses that arose sporadically in the finance markets. In Rothbard's view, the cycle of generalized malinvestment is greatly exacerbated by centralized monetary intervention in the money markets by the central bank.
Rothbard argues that an over-encouragement to borrow and lend is initiated by the mispricing of credit via the central bank's centralized control over interest rates and its need to protect banks from periodic bank runs (which Austrians believe then causes interest rates to be set too low for too long when compared to the rates that would prevail in a genuine non-central bank dominated free market).
Read more about this topic: Austrian Business Cycle Theory
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