On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory

VIII. The Aims and Method of Cyclical Policy

VIII The Aims and Method of Cyclical Policy 1. Revised Currency School Theory Without doubt, expanding the sphere of scientific investigation from the narrow problem of the crisis into the broader problem of the cycle represents progress.1 However, it was certainly not equally advantageous for political policies. Their scope was broadened. They began to aspire to more than was feasible. The economy could be organized so as to eliminate cyclical changes only if (1) there were something more than muddled thinking behind the concept that changes in the value of the monetary unit can be measured, and (2) it were possible to determine in advance the extent of the effect which accompanies a definite change in the quantity of money and fiduciary media. As these conditions do not prevail, the goals of cyclical policy must be more limited. However, even if only such severe shocks as those experienced in 1857, 1873, 1900/01 and 1907 could be avoided in the future, a great deal would have been accomplished. The most important prerequisite of any cyclical policy, no matter how modest its goal may be, is to renounce every attempt to reduce the interest rate, by means of banking policy, below the rate which develops on the market. That means a return to the theory of the Currency School, which sought to suppress all future expansion of circulation credit and thus all further creation of fiduciary media. However, this does not mean a return to the old Currency School program, the application of which was limited to banknotes. Rather it means the introduction of a new program based on the old Currency School theory, 1. Also, as a result of this, it became easier to distinguish crises originating from definite causes (wars and political upheavals, violent convulsions of nature, changes in the shape of supply or demand) from cyclically-recurring crises. aims and method of cyclical policy • 149 but expanded in the light of the present state of knowledge to include fiduciary media issued in the form of bank deposits. The banks would be obliged at all times to maintain metallic backing for all notes—except for the sum of those outstanding which are not now covered by metal—equal to the total sum of the notes issued and bank deposits opened. That would mean a complete reorganization of central bank legislation. The banks of issue would have to return to the principles of Peel’s Bank Act, but with the provisions expanded to cover also bank balances subject to check. The same stipulations with respect to reserves must also be applied to the large national deposit institutions, especially the postal savings.2 Of course, for these secondary banks of issue, the central bank reserves for their notes and deposits would be the equivalent of gold reserves. In those countries where checking accounts at private commercial banks play an important role in trade—notably the United States and England—the same obligation must be exacted from those banks also. By this act alone, cyclical policy would be directed in earnest toward the elimination of crises. 2. “Price Level” Stabilization Under present circumstances, it is out of the question, in the foreseeable future, to establish complete “free banking” and place all banking transactions, including the granting of credit, under ordinary commercial law. Those who speak and write today on behalf of “stabilization,” “maintenance of purchasing power” and “elimination of the trade cycle ” can certainly not call this more limited approach “extreme.” On the contrary! They will reject this suggestion as not going far enough. They are demanding much more. In their view, the “price level” should be maintained by countering rising prices with a restriction in the circulation of fiduciary media and, similarly, countering falling prices by the expansion of fiduciary media. The arguments that may be advanced in favor of this modest program have already been set forth above in the first part of this work. In our judgment, the arguments which militate against all monetary 2. [The Post Office Savings Institution, established in Austria in the 1880s and copied in several other European countries, played a significant, if limited, role in monetary affairs. See Mises’s comments in Human Action (1966, 1996, and 2007), pp. 445–446.—Ed.] 150 • monetary stabilization and cyclical policy manipulation are so great that placing decisions as to the formation of purchasing power in the hands of banking officials, parliaments and governments...