Buttonwood of The Economist has this very interesting read where the author compares the euro to a form of a ‘gold standard’ because countries in the euro-zone cannot pay off their debt by inflating euros, as the euro is controlled by the European Central Bank (ECB).
The downside of this is that if the ECB decided to inflate the euro, there is nothing that a euro-zone country can do about it, other than leave the euro-zone. And, since monetary policy is decided by the ECB, there is a higher risk of euro-zone business cycles, should the ECB decide to have artificially low interest rates. That is always a possibility with central banking, which is really nothing more than the central planning of the banking industry by a private organisation. The problem with central banking, therefore, is trying to determine the ‘appropriate’ interest rate(s). There is always a very good chance that the interest rate will be artificially too low or too high.
This is further evidenced by the fact that the an increase in the stock of money is most often a leading, procyclical trend of the business cycle. This means that the stock of money reaches its peak before GDP reaches its peak (boom) prior to the eventual decline (bust) of GDP.
The only reason to borrow money is to use it, to consume or invest. Because of this, the demand for loans has an indirect, positive relationship with the demand for the goods to be purchased with such loans. One of the most important of these relationships is the relationship between various loans and the demand for certain types of capital, where capital is factor of production—a good that is used in the production of other goods or services that is not completely used up in the process of production (examples would include buildings, vehicles, equipment, etc.).
Artificially low interest rates require a surplus in the stock of money, i.e. the creation of new money. Because of the workings of inter-market monetary flow (money cycles; it doesn’t stay in just one market, especially since lowering interest rates increases the opportunity cost of saving), this surplus of money leads to malinvestment, particularly in the markets for capital goods.
Another reason for the leading trend of the money stock is that all investment, including malinvestment, is included in GDP, so if malinvestment increases (ceteris paribus), GDP will likewise increase.
Eventually, of course, malinvested capital looses its market value, causing the bust, the decline in GDP.
