Austrian Business Cycles and the Market for Loanable Funds
•Figure 1(b) shows the effect of an increase in credit creation brought about by a monetary expansion from the Federal Reserve. This results in a shift in the supply curve from S to S+ MS’.
•This increase is not based on real households savings; only the injection of new money created by the Federal Reserve.
•As the market-clearing rate of interest falls from I’ to i, businesses increase investment by the amount AB, while genuine saving actually falls by the amount AC.
•Inflating the supply of loanable funds with new money keeps the interest rate artificially low. This drives a wedge between saving and investment.
•This has stimulated temporary vs. sustainable growth, or an artificial boom. The result is unsustainable. A bust follows, and investment falls back into line with saving (not shown in figure 1(b).
Adapted from : David Glasner, ed., Business Cycles and Depressions
New York: Garland Publishing Co., 1997, pp. 23-27