Credit Injection, Empirically

I haven’t been too involved with the debate on Cantillon effects, largely because I’ve been busy with other things. But, I’d like to make a quick comment on a recent post by Nick Rowe (H/T Robert Murphy) on the topic, just to clarify what Hayek and other Austrians actually have in mind. Near the beginning, Rowe writes,

Hayek assumed that newly-printed money is injected via the credit market, where it pushes down the market rate of interest relative to the natural rate of interest, and this causes people’s plans and expectations to be mutually inconsistent, and this causes an unsustainable change in the time-structure of production.

But Hayek’s assumption is obviously usually wrong.

My first reaction was, “No, Rowe is obviously wrong.” My second reaction was, “In part he’s right, but there’s something about this argument that is ignoring key aspects of the Mises–Hayek theory.” Because I haven’t been involved with the debate, it’s difficult for me to frame this within the context of said debate, but I think excessive focus on the Federal Reserve (which could be the fault of any [or both] side[s]) is drawing attention away from what makes Hayek’s assumption “obviously usually right.”

When the Fed injects money, Rowe is right that it can do so through various avenues. It can buy U.S. Treasuries through open market operations, both from banks holding these assets or from the government proper (less likely?), or it can control base money through short-term interest rates, et cetera. But, the Fed, in the role of credit expansion specifically, is really a “minor player,” in that most of the credit expansion comes as a result of private bank lending — this being said, the Fed is a “major player” in that it shapes the banking industry and decides the extent of credit expansion (i.e. if Selgin’s banking model in the Theory of Free Banking is correct, credit would be much more restricted in a competitive banking system). Hayek, in “Monetary Theory and the Trade Cycle” (e.g. p. 77 [in the Mises Institute's hardback edition of Prices and Production and Other Works]), explicitly recognizes the role of private banks (the “existing credit organization”) in perpetuating credit expansion.

So, when Hayek is talking about the “inconsistency of plans and expectations,” in the context of the business cycle, the credit injections specific to Fed action are quite limited relative to the participation of private market financial firms. Although Rowe told me he doesn’t get Hayek’s theory, the last few paragraphs of his post say otherwise — what matters is the effect of base money on the extent of private market credit expansion.

To make my point clearer, let’s reformulate my argument to directly respond to the following claim by Rowe,

If Austrian economists are right to insist that it really really matters where the new money is injected into the economy, then Hayek was making a very special assumption, one that is nearly always empirically false, and false in a way that matters a lot, and so Hayek’s analysis is mostly irrelevant.

What Rowe may not realize is that the “special assumption” is actually his: the Fed is not the only organization/firm that injects new money into the economy. Banks also create money through loan over-extension, or credit expansion, “in a way that matters a lot,” making Hayek’s analysis mostly relevant. If you want some empirical evidence,

Bank Credit of All Commercial Banks (TOTBKCR)


  • Chris Pacia

    Good post. I would mention though that what originally sparked the whole debate were Sheldon Richmond’s comments about money injections and the distribution of wealth.

    The whole point of the (initial) debate was whether the injection of money actually makes some groups wealthier at the expense of others. Hence the discussion of Cantillon Effects. I still don’t know what Sumner and Rowe believe about it. It seemed like Sumner first vehemently denied such a thing is possible, then back away from that claim, then doubled down on it again. Who knows.

    The discussion of interest rates was just an outgrowth of the discussion of the effects of monetary expansion on the distribution of wealth.

    • JCatalan

      That’s what I figured, although I haven’t read Richmond’s piece yet. I do think there are indirect effects of credit expansion on the distribution of wealth, including distributing income to the financial sector away from low and middle income families. But, this might not talk directly to what Sumner, et. al., are discussing; but I haven’t done my homework with regards to that specific debate.

  • Greg Ransom

    When Hayek uses the term “injections” in Price and Production, he is explicitly referring to the point where the expansion of money and credit moves from the financial system to industrial investments in production processes.

    (Prices and Productions was re-written by Lionel Robbins, so the language here is likely Robbins work.)

  • Woj

    I’m late getting around to this, but really good thoughts here. There is often much confusion surrounding Hayek’s views about money vs credit, but I think your spot on in showing he generally accepted private bank credit as a means of monetary expansion (at least later on). You also make an important point about the amount of credit that stems from private banks relative to central banks. This is why I have been skeptical that the Fed’s actions could or would produce any sustainable growth or inflation.

    One point that confused me a bit was the discussion of various avenues through which the Fed can inject money. Legally the Fed is not permitted to purchase Treasuries directly at auction, which rules out that avenue. As for the other ways, they all appear to be variations on which securities are exchanged by the private sector through OMOs and repos. Are there other avenues you were suggesting that I’m missing?

    • JCatalan

      You’re right regarding the Fed buying directly from the government, my mistake.