Between Wicksell and Hayek: Mises' theory of money and credit revisited - Special Invited Issue: Money, Trust, Speculation and Social Justice - Part 2: Trust and Money

American Journal of Economics and Sociology, The, Oct, 1998 by Riccardo Bellofiore

The more "capitalistic" (roundabout) production processes could be introduced only by taking labor and intermediate goods away from old production lines. These are now made on a reduced scale, which means a reduction of supply at the end of the period. The longer production processes will be able to produce more (or different) consumption goods only in the future. If we suppose with Mises that the wage earners consume the whole of their income, then, given that the available output at the beginning of any specified period is leftover from the previous one, the increase in money wages will for face an unchanged real supply of consumption goods. The price of consumption goods rises in proportion to the nominal wage and, hence, workers' wages remain constant.

Mises' argument supports the idea that expansion on the part of the banks generally leads directly to a fall in the relative price of consumption goods over production goods and the interest on capital.(38) At this point, forces on the real side of the model pull in the opposite direction. In the following period, the effects of the lengthening of the average production period are felt. Labor and intermediate goods are moved toward even earlier processes, now reducing the present supply at wage earners' disposal for consumption in this period. The increase in prices and wages in the preceding period raises the demand for finance, which the banks satisfy fully. The wage-bill rises again just when the available quantity of consumption goods is falling because the old, shorter, lines employ fewer production goods and the new, longer, ones have not yet come to completion. Thus, the prices of consumption goods go up further as the workers' real consumption shrinks. Here is a classic case of "forced saving," which can be made harsher if capitalists and entrepreneurs enlarge their consumption, that is, if they reduce their savings because of the lower interest rate.(39) Unless bank finance is again raised for the stages of production that are furthest from consumption, inflation in the price of consumption goods will rise faster than that in the price of production goods; consequently, interest on capital, which had fallen, will now turn around and move back to a higher level.(40)

In the Theory, Mises stops at this point, with the definition of the upper turning-point. The readjustment mechanism can be identified with the movement of the price of higher-order goods relative to the lower-order goods, which is in turn driven by changes in the production structure. The crisis is started by the issue of new fiduciary media, which causes a greater withdrawal of production goods (capital, labor) from the production of consumption goods than is justified by the propensity to save. Because production takes time, excess investments relative to voluntary saving show up as misdirected investments.(41) Once there has been a reversal of the profitability accruing to the processes of production of the various orders of goods, it becomes worthwhile to shorten the production period again. The increase in the production of consumption goods takes resources away from the new, longer processes that had been started after banks' expansionary initiative. They cannot be brought to completion on the scale projected or turn out to be hopeless failures.(42) If the banks do not resist the upward pressure on loan interest rates, deriving from the individuals' preferences about the allocation of income between consumption and saving, then the system will tend to a new equilibrium, with no inflation but with a higher price level.(43,44)