“When the interest rate is artificially lowered by credit expansion [as it was during 2001-2004 and again in 2007-2008] the false impression is created that enterprises which previously had been regarded as unprofitable now become profitable. Easy money induces the entrepreneurs to embark upon businesses which they would not have undertaken at a higher interest rate. With the money borrowed from the banks they enter the market with additional demand and cause a rise in wages and in the prices of the means of production. This boom of course would have to collapse immediately in the absence of further credit expansion, because these price increases would make the new enterprises appear unprofitable again. But if the banks continue with the credit expansion this brake fails to work. The boom continues.

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a ?crack-up boom? and in a collapse of the money and credit system.[1] Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

It is obvious that a mere banking process like credit expansion cannot create more goods and wealth. What the credit expansion actually accomplishes is to introduce a source of error in the calculations of the entrepreneurs and thus causes them to misjudge business and investment projects. The entrepreneurs act as if more producers? goods were available than are actually at hand. They plan expansion of production on a scale for which the available quantities of producers? goods are not sufficient. These plans are bound to fail because of the deficiency in the available amount of producers? goods. The result is that there are plants which cannot be used because the complementary facilities are lacking; there are plants which cannot be completed; there are other plants again whose products cannot be sold because consumers desire other products more urgently which cannot be produced in sufficient quantities because the necessary productive facilities are not ready. The boom is not over-investment, it is misdirected investment.”

http://mises.org/etexts/mises/interventionism/s...

Step Eight