Out of all the prices in the market place, the most important price unequivocally is the price of money- the interest rate. Contrary to Federal Reserve principles, interest rates are not arbitrary numbers that can be adjusted as necessary to create desired economic results, without negative consequences. They actually play a significant coordinating function in the allocation of capital from investors to entrepreneurs needing funding. This is why Austrians typically disapprove of the Federal Reserve’s actions. One of the FED’s stated goals is to moderate the interest rate to promote sustainable growth. The way it does this is through expanding and shrinking the money supply. However, since these decisions in monetary policy tamper with the critical organizing role of interest rates, it gives entrepreneurs wrongs signals and causes erroneous business making decisions.
Generally, when the Federal Reserve does interfere with the interest rate, it does so to lower them below where the market would naturally set them. This ultimately causes mal-investments and creates what is known as the boom-bust cycle. Nobel Laureate Fredrick Hayek, a student of Ludwig von Mises, in his writings during the 1930’s elaborately explains how disturbances in the monetary system create imbalances in investment that are unsystematic and unsustainable. Central banks generally attempt to force down interest rates by means of flooding the economy with cheap money through its open market operations. Hayek’s theory is that the lowered interest rate disproportionately stimulates investments in longer term ventures which creates an exponential boom in economic growth in the short-run. However that boom is unsustainable and is always followed by a severe and painful recession. Freely fluctuating interest rates are vital to a healthy economy and disrupting the balanced synchronization between immediate and long-term projects orchestrated by interest rates naturally set by the free market will always lead to unintended harmful results.