Mises Wire

A
A
Home | Blog | Financial Times Letter Confuses Credit and Savings

Financial Times Letter Confuses Credit and Savings

February 6, 2008
The Feb 5 Financial Times published a letter stating:
Sir, The widespread consensus that the aggressive interest rate cut policy adopted by the then Federal Reserve chairman Alan Greenspan after the tech bubble's burst caused the recent market turmoil is totally misleading. The Fed by making money cheaper has determined a large-scale tendency to borrow money for making investments. This has sustained economic growth.
The error here is that credit does not fund economic growth, only actual savings. Firms can borrow, but they can only use borrowed funds for productive activities by purchasing or renting land, labor, and capital. These factors at all times scarce and their supply is not increased by creating more credit. What the Fed can do is to create (or enable banks to create) credit that is not funded by voluntary savings. This will increase demand for productive factors, raising their prices. This can result in some additional involuntary saving (also called "forced savings") as the recipients of the excess credit are able to bid away goods from buyers who would have used them for consumption, or used them closer to the consumption end of the structure of production. The process described in the previous paragraph - increases in the prices of some productive factors combined with forced savings, is the Mises-Hayek theory of the business cycle. The theory shows that these shifts in production are unsustainable because they are not consistent with consumer demand, and therefore not true economic growth. The free market rate of interest is that rate where credit is equal to voluntary savings. Low market interest rates that come about through a high savings rate do increase economic growth. But for the central bank to set interest rates below the market rate does not because this artificial rate does not represent a shift on the part of the public from consumption to savings. -Robert

Follow Mises Institute

Add Comment