The expectation of further price increases leads investors and borrowers alike to attach lower value to future money in particular. This lower valuation expresses itself in higher interest rates, as lenders increasingly insist that an "inflation premium" be built into the interest rate, while borrowers (who know that they will repay with depreciated money) become increasingly willing to accept that premium in loan contracts. The resultant soaring interest rate, because it now includes an inflation premium, can easily exceed the natural interest rate that would have been realized in the absence of the original inflationary intervention. High interest rates now threaten to reverse the politically desirable effects of that intervention, effects which as seen above (pp. 4.11:42-3) required an artificially depressed interest rate. If no action is taken, then high wages will immediately plummet (at least, in purchasing power), and the "boom" will go "bust."

At this point the political authority—often a different administration than the one that initiated the inflationary policy—faces a dilemma:

  1. It can attempt to bring interest rates back down by inflating the money supply still further; or

  2. It can allow the interest rate to rise, ushering in a recession or depression.      Next page
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