Humor me here won't you?
An increase in the money supply (i.e. inflation) will lead to an increase of interest rates and from this a cluster of malinvestments down the production structure. Whether this inflation is caused by the state central bank or private banks, this will will be the consequence, correct?
Now would a sudden decrease of the money supply also cause this cluster of errors? I presume that unlike an inflationary business cycle though this deflationary cycle would leave to malinvestments in the form of individuals not taking on investments despite savings existing for them. This is as opposed to an inflationary cycle in which individuals take on more investments than there are savings for. I vaguely recall in HA Mises discusses this briefly, but he doesn't go into much detail so any help would be greatly appreciated here.
People will borrow less, the economy sectors which normally gets a lot of borrows will shrink as if it was a fallen industry, demand will fall, production will fall. At the same time, with good interest rates, people will save more (and consume less, increasing the first effect).
Maybe there willbe unemployment on those shrink sectors and the related ones -- and it will spread all over the economy.
The deflation can't go forever, 'cause the Central Bank has a limited number of bonds to sell and get the money out of the economy.
When the deflation stops, it's likely that all those savngs will now be used to refinancing and reconstructing the sectors affected by the deflation.
I'm just thinking of it right now. It is not clear for me if people will save more and more money because of the interest rates and never attempt to buy the falling prices stuff.
Other thing is where does the saved money go and how is it worth when one tries to rebuild the economy afterwards. Money doesn't worth anything. Just the man work matter. Isn't it waste when people just sit down and "save" (i.e. give money to the banks and wait for interest payment)?