Fiat Monetary Inflation Results in the Interest Rate Being Unable to Perform Its Proper Function of Allocating Resources between Production and Consumption

Perhaps the most thorough-going “free market” textbook in the 1950s was John V. Van Sickle and Benjamin A. Rogge's Introduction to Economics. Van Sickle and Rogge advocated an international gold standard and were critical of Keynesian economics. They used an elementary Crusoe model (a common device in old-fashioned principles texts) to support the case for increased savings and capital formation as sine qua non for economic growth. Crusoe eventually saves time and increases his standard of living by investing his labor in building a cabin, a water trough and other “round-about methods of production.”

Van Sickle and Rogge were highly critical of Keynesian economics in a chapter called “The Theory of Effective Demand.” A countercyclical spending policy by the government to increase “effective demand” during a recession was unnecessary, they argued, because “a reasonable amount of flexibility in wages and other cost elements is adequate to prevent widespread unemployment.”

The Keynesian critique was followed by the detailed chapter “Alternative Theories,” including the Hawtrey-Simons monetarist position and the Hayek-Mises “structural disequilibrium theory.” According to the Hayekian interpretation of the business cycle, fiat monetary inflation results in a situation where “the interest rate is not permitted to perform its proper function,” that is, to allocate resources between production and consumption. The business cycle is caused by “unwarranted changes in the production-mix, with first too many, then too few, resources being devoted to the production of capital goods.”

According to Van Sickle and Rogge, monetary inflation causes an excessive boom and artificially-inflated incomes.

When this newly created money reaches consumers, as it must when it is spent to acquire resources, they will use it to bid resources back into the production of consumer goods. This will cause serious difficulty to the investors who have not as yet completed their capital goods' projects, and many of those projects will have to be abandoned with great losses. Moreover, because resources do not move back and forth between the consumer goods and the capital goods industries with complete freedom, there is certain to be some unemployment. 

—Mark Skousen, The Structure of Production, new rev. ed. (New York: New York University Press, 2015), Kobo e-book.

Technically, a Business Cycle Is Generated by Movements of Interest Rates Which Affect Relative Prices in Such a Way as to Cause False Expectation, According to Lionel Robbins

Robbins discussed the basic cause of business cycles. Technically “a business cycle is generated by movements of interest rates which affect relative prices in such a way as to cause false expectation.” In his explanation, he made a distinction between consumers' goods and producers' goods. Interest rates are pushed lower.

This means that the profitability of all forms of production which involve making things which only yield services at a later date, or over a long period of time, in increased. . . . The longer-lived the capital instrument, or the greater its distance from consumption, the more its value is affected by the change in the rate of interest. The shorter-lived it is, or the less its distance from consumption, the less it is affected. The value of flour in the baker's shop is hardly affected by a cheapening of the cost of borrowing. The value of mines, forest, houses and heavy factory equipment is enormously affected.

Robbins' plan for recovery included the reestablishment of an international gold standard, stable exchange rates, removal of trade barriers, and greater flexibility in prices and wage rates. He opposed the interventionist policies of maintaining wages and consumer demand, propping up business bankruptcies, and limiting farm output.

--Mark Skousen, The Structure of Production, new rev. ed. (New York: New York University Press, 2015), Kobo e-book.

Gross Domestic Product (GDP) or Gross Output (GO): Measuring the "Use" Economy or the "Make" Economy

What is Gross Output? It is an attempt to measure total sales volume at all stages of production, what we might call the "make" economy. Most importantly, it includes all business-to-business (B2B) transactions that GDP leaves out. In the third quarter of 2014, GO hit $31.3 trillion, almost twice the size of GDP, which was $17.6 trillion.

GDP is the standard yardstick for measuring the value of final goods and services purchased by consumers, businesses, and government in a year, what we call the "use" economy. While GDP measures the "use" economy, now with GO we have a way to measure the "make" economy every quarter too. Finally, we have a full picture of the economy.

--Mark Skousen, introduction to the new revised edition of The Structure of Production, new rev. ed. (New York: New York University Press, 2015), Kobo e-book.