Fallacy - Low Interest Rates Foster Growth

Central banks seek to foster price stability and economic growth through their interest rate policies. However, since central banks do not themselves provide real resources to the economy, they cannot grow the economy directly. All they can do is interfere in capital markets by distorting price mechanisms. The idea that central banks are a benefit to the economy rests therefore entirely on the idea that price distortions are better than no price distortions.

When central banks choose to interfere in the economy, they do this by setting interest rates either higher or lower than what the market would have done. When setting interest rates lower, they make it easier for businesses to do things that would otherwise be unprofitable. We get production of goods and services for which there is little real demand. We get zombie businesses that exist solely due to the low cost of money. These businesses consume real resources without adding any value, with a general impoverishment as a consequence. We also get credit based consumption in which individuals spend today what would otherwise be spent at a later date. This distorts the time aspect of consumption, making people feel rich now by letting them steal from their future selves. Resources are miss-allocated, and time preferences are manipulated. None of this fosters growth.

When central banks on rare occasions set the interest rate higher than a free market would demand, we get the destruction of viable businesses. This too is clearly counterproductive.

By U.S. Government - Extracted from PDF version of the Federal Reserve's Purposes & Functions document (direct PDF URL [1])., Public Domain, Link