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ECONOMISTS IN THE TRADITION OF THE AUSTRIAN SCHOOL have shown that one type of maturity mismatching can cause maladjustments and business cycles. When banks expand credit, by granting loans and creating demand deposits, they generate immediately withdrawable liabilities to finance longer-term loans. The newly created demand deposits do not represent a reduction of consumption, i.e., that characterized by real savings. As a consequence, interest rates are artificially reduced under the level they would have been in a free market reflecting real savings and time preference rates. Thus, entrepreneurs are prone to engage in more and longer projects than could be financed with the available supply of real savings. Before all projects that are financed by the credit expansion are finished, a bust occurs. An absence of real savings to sustain the factors of production in the production processes and to produce complementary and necessary capital goods becomes evident. As a result, malinvestments are liquidated and the structure of production is brought in line with consumer preferences again. This is the Austrian Business Cycle Theory (ABCT) in a nutshell.

Austrian business cycle theory: are 100 percent reserves sufficient to prevent a business cycle?