Business Cycle

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    If increasing the money supply does not increase wealth, then how come we have a boom phase to the business cycle when the Federal Reserve inflates the supply of money via its open market operations and quantitative easing? I understand that more money does not equal more wealth and that the Fed causes the boom and bust (ABC Theory), but it still seems that more wealth is created as a result of more money. The term “boom” implies wealth creation. Is that not real wealth? If not, why not? Does it have to do with the Cantillon effect? If so, what is that exactly? Thanks.


    Monetary inflation and credit expansion raise money incomes, but lower real incomes. Wealth refers to real incomes, i.e., people’s standards of living or the consumer goods people have. Wealth increases through capital accumulation which raises productivity of inputs and results in the production of more and better consumer goods. To accelerate capital accumulation, people must lower their time preferences, releasing resources from producing consumer goods more directly and reallocating them into more indirect production of consumer goods. Monetary inflation and credit expansion shift resources into more indirect production processes even though people do not prefer them as they have not lowered their time preferences. The ensuing alteration is called a “boom” instead of economic growth because it involves a building up of the economy’s capital structure, seemingly aping the process of economic growth, which proves to be unsustainable. Because the build-up is not justified by lower time preferences, it must be torn down in the bust.

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