Now the specific timing of the collapse is related to the actions of the banks. In the typical scenario, they eventually abandon their inflationary policy, perhaps because they fear a drain on their reserves under a commodity standard or because the central bank becomes alarmed at the rapid price increases under a fiat standard. This leads to a slowdown or even fall in the quantity of money and a rise in interest rates. At the higher interest rates, many entrepreneurs realize that their projects are now unprofitable; the boom collapses, and the bust ensues.

Yet Mises is quite clear that even if the banks continued with their inflationary policy, eventually the boom would end when the price inflation had grown so severe that the public abandoned the currency altogether. Mises called this horrendous outcome the crack-up boom. In this scenario, once the public has switched currencies, their underlying real time preferences would assert themselves in the market rate of interest, showing many of the entrepreneurs that they had greatly erred during the false prosperity of the boom.

Bob Murphy