How does one address the claim that over expansion of credit through installment-plan buying helped lead to the depression? The argument claims that buying on credit over-stimulated production and many consumers dived in beyond their depth and could not pay back their loans, thus leading to a downward spiral.
Without central bank monetary inflation and credit expansion, the supply of credit would be determined by people’s saving. Unless people decide to save more, the pool of credit available would stay the same. Any additional credit into consumer loans would have to come out of credit being supplied into producer loans. Production would then be stimulated in consumer goods, but suppressed in producer goods. This would be the effect of an increase in consumer credit without considering any other factor.
The facts of the boom of the 1920s, however, are quite different. Both consumer credit and producer credit expanded together. The cause of the overall expansion of credit was not more saving, but expansionary monetary policy by the Fed and the resulting credit expansion by the banking system. As interest rates were suppressed by the credit expansion, consumers saved less and consumed more. Their increased consumption was financed partially money they borrowed. Banks, looking to expand credit offered better terms for consumer credit (e.g., lower-interest-rate and longer-maturity mortgages) which was the cause of the expansion of consumer credit. At the same time, banks were extending cheap mortgage money to farmers who used it to buy capital equipment and make capital improvements on their land.
The monetary inflation and credit expansion process of the 1920s is chronicled in Murray Rothbard’s book, America’s Great Depression, and Benjamin Anderson’s book, Economics and the Public Welfare.