Credit Expansion and Submarginal Investments

Markets are ruthlessly efficient, meaning in large part that people will not undertake investment projects with risk characteristics that are not aligned with savers’ preferences. All profitable opportunities will be exploited in equilibrium, and no potentially profitable projects will be left undone. One of the unfortunate consequences of credit expansion is that many projects which were formerly passed over by investors will be undertaken because of the incorrect signal sent into capital markets by artificially reduced interest rates. These problems will be compounded by the fact that savers will pull real resources out of the capital market, meaning that previously profitable investment projects will now be unprofitable malinvestments. FULL ARTICLE