Why The Boom-Bust Cycle Keeps Repeating

In a free, unhampered market, we could envisage that the economy would be subject to various shocks but it is difficult to envisage a phenomenon of recurrent boom-bust cycles.

According to Rothbard,

Before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subjects; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.1

The boom-bust cycle phenomenon is somehow linked to the modern world. But what is the link? The source of the recurring boom-bust cycles turns out to be the alleged "protector" of the economy — the central banks themselves.

A loose central bank monetary policy, which results in an expansion of money out of “thin air” sets in motion an exchange of nothing for something, which amounts to a diversion of real wealth from wealth-generating activities to non-wealth-generating activities.

In the process, this diversion weakens wealth generators, and this, in turn, weakens their ability to grow the overall pool of real wealth.

The expansion in activities that are based on loose monetary policy is what an economic "boom" (or false economic prosperity) is all about. Note that once the central bank's pace of monetary expansion has strengthened the pace of the diversion of real wealth is also going to strengthen.

Once however, the central bank tightens its monetary stance, this slows down the diversion of real wealth from wealth producers to non-wealth producers. Activities that sprang up on the back of the previous loose monetary policy are now getting less support from the money supply; they fall into trouble — an economic bust or recession emerges.

Irrespective of how big and strong an economy is, a tighter monetary stance is going to undermine various non-productive or bubble activities that sprang up on the back of the previous loose monetary policy.

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