The link between ’fiat money’ and boom-and-bust cycles

The link between ‘fiat money’ and boom-and-bust cycles (IEA):

.... interest rates ought to reflect society’s ‘time preference’, the degree to which people are willing to forego consumption today in exchange for (greater) consumption tomorrow.

This rate determines the ‘time structure’ of an economy - the allocation of resources between consumption and investment purposes. It also affects the distribution of investment funds between projects that pay off after a short time and those that require a longer period.

In the Austrian interpretation, the interest rate is the key parameter in the coordination of economic activities. Manipulating it can upset the whole balance of the economy.

If the central bank injects more money into the economy by pushing interest rates below the ‘natural rate’, market actors are lured into believing that people have become more ‘patient’. Hence, additional investment projects are started, especially ones with a long-term horizon.

But these projects are castles built in the sky, because no additional funds for investment have been made available. People’s time preference has not changed. Eventually, the shortage of capital must come to light, interest rates must rise again, and a lot of projects fail. In the Austrian view, the ‘bust’ really means that the time structure of the economy is brought back into line with society’s preferences.