Turn on the Printing Press?

Indulge me a little amateur economics here.

I think that the Austrians would tell us that credit is massively important to the money supply. Extending credit, by levering against collateral, is essentially introducing money into the system.

As an example, if somebody deposits $200 in a bank, and the bank's reserve-to-loan ratio is five to one, then the bank can lend out $1000 that can be spent on inventory or buildings or what have you. This essentially adds $800 to the money supply and in a simple world of nothing created or lost that $800 can go chase the same amount of goods, thereby driving up the cost of things. This is inflation as sure as if the Fed had added eight one-hundred dollar bills. Credit gets extended year after year at about the same rates, and as the money supply grows the whole thing pretty much works in sync.

However, over the last decade or so "financial innovation" meant that ever more credit was squeezed out of each dollar invested (risk metrics and what not.) Part of this was fancy calculation, part was plain old laxer lending standards, and part was widespread fraud. All of which had the effect of increasing the multiplier, and thereby effectively increasing the money supply - viz. inflation. (Although, as Von Mieses would tell you, the sector where the money went into the system saw the effects first.)

When the prices of housing and its ilk (the sector where the money went into the system) fell apart, the supply of money (collateral that had just become worthless) suddenly decreased, and there was a massive deflationary wave thrown through the system. All of the money that had the fueled the (at least perceived) boom disappeared and you had fewer funds chasing the same amount of stuff.

So, my question then would be this: To avoid a deflationary spiral, wouldn't the answer have to be to bring the money supply into line with the prices of things (at least averaged over the economy)? Which is to say, haven't we already had massive inflation and now the thing to do is just add back in the money that suddenly went away before we deflate the thing back to the 30s?

Sure it'll be devastating to those on fixed incomes, the poor, and the savers, but hasn't it already happened whether we admit it or not?