Von Mises Philosophy

During this period, in his first great work, The Theory of Money and Credit (1912) Mises performed what had been deemed an impossible task: to integrate the theory of money into the general theory of marginal utility and price (what would now be called integrating “macroeconomics” into “microeconomics.”) Since Bohm-Bawerk and his other Austrian colleagues did not accept Mises’s integration and remained without a monetary theory, he was therefore obliged to strike out on his own and found a “neo­-Austrian” school.

In his monetary theory, Mises revived the long forgotten British Currency School principle, prominent until the 1850s, that society does not at all benefit from any increase in the money supply, that increased money and bank credit only causes inflation and business cycles, and that therefore government policy should maintain the equivalent of a 100 percent gold standard.

Mises added to this insight the elements of his business cycle theory: that credit expansion by the banks, in addition to causing inflation, makes depressions inevitable by causing “malinvestment,” i.e. by inducing businessmen to overinvest in “higher orders” of capital goods (machine tools, construction, etc.) and to underinvest in consumer goods.

The problem is that inflationary bank credit, when loaned to business, masquerades as pseudo-savings, and makes businessmen believe that there are more savings available to invest in capital goods production than consumers are genuinely willing to save. Hence, an inflationary boom requires a recession which becomes a painful but necessary process by which the market liquidates unsound investments and reestablishes the investment and production structure that best satisfies consumer preferences and demands.

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The policy prescriptions for business cycles of Mises-Hayek and of Keynes were diametrically opposed. During a boom period, Mises counseled the immediate end of all bank credit and monetary expansion; and, during a recession, he advised strict laissez-faire, allowing the readjustment forces of the recession to work themselves out as rapidly as possible.

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