In a recent Libertarian Papers article, Vijay Boyapati reckons that the Austrians have got it wrong, and we do not need to worry about Inflation: the banks are still scared stiff and aren't about to spread any of the monetary authorities' new cash around any time soon.

Milton Friedman (as you will be able to learn shortly from my forthcoming book on him) of course thought the Austrian explanation was completely up the spout: the surge in credit in past boom/bust cycles, he believed, was not enough to explain the scale of the inflation. And he knew something about economic data. I am not so sure, but I do think that the circumstances of each boom/bust cycle must be taken into account, and often give Austrians a run for their money.

Still, it depends on how 'hot' is 'hot money' (the monetary base which officialdom controls). The reality has been that banks can lend dozens of times what they keep in their vaults...and then those loans allow other banks to do the same. So a small amount of money creation or quantitative easing can have really huge effects – if the banks choose to lend up to their maximum.

During expansions, there is every incentive for banks to lend up to their maximum. In the booming economy, every deal works. So bank executives are incentivized with generous bonuses to take on more and more new business, not bothering too much about its quality, because however poor it is, the rising tide will still lift it. As the Austrians point out, it is only when the rate of expansion slows that the malinvestments are exposed and then there is an enormous shake-out as, one after another, the bad deals of the past are exposed.

The shock of all that – and pressure from governments – has caused banks to tighten their lending and put keep more money in their vaults. Nearly all the new money that has been created still sits in those vaults, or has been given back to the government in exchange for the bonds it has been printing in order to borrow enough cash to keep the show on the road. So the quantitative easing has not done much for the real economy, which means that it has not had much effect in driving up prices. But as it does leach out, it will. Indeed, inflation in the UK has been over target for month after month: there is always some 'short term factors' explanation, but eventually those short-term episodes become the long term. The question then is whether the monetary authorities have the bottle to rein back, which is a lot harder to do than presiding over an expansion. Past experience does not encourage one that they will.