When bank credit expands owing to the machinations of central banking, it in turn causes an artificial lowering of interest rates; consequently, the savings rate appears to be higher than it actually is. This distorts the business community’s perception of consumer time preference, leading them to begin new projects and invest in longer-term factors of production. An artificial boom begins.
For a time, there is the appearance of prosperity. But when the credit expansion ends, the business expansion undertaken during the boom is revealed as malinvestment, and the bust ensues. Businesses must then liquidate assets, exit lines of business or fold entirely, turning their assets over to creditors, better run or more fortuitous firms. For consumers, the end of the expansion typically involves cutting back on spending, increasing rates of saving, and paying down (or defaulting upon) debt.