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Told you so.

Onion Eater

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Question #2 of my economics quiz asks:

Which of these statements about interest rates do you agree with?

a) Interest rates are pro-cyclical; they are up in good times and down in bad.

b) Interest rates are anti-cyclical; they are down in good times and up in bad.

c) Interest rates are unimportant; it is credit limits that affect the business cycle.

These answers reflect the mainstream, Austrian and axiomatic positions, respectively.

I explain:

Are interest rates procyclical [up in good times, down in bad] or anticyclical? In six words this question summarizes the difference between Hayekians and Keynesians. Keynesians believe, and every modern textbook proclaims, that interest rates are procyclical because the government is expected to lower them in its effort to rescue capitalism from its periodic bouts with recession. Hayekians believe that they are anticyclical because low interest rates lengthen the period of production, causing a boom, and then, when the currency is inevitably attacked, the defensive raising of interest rates shortens the period of production, causing a bust.

Basically, Keynesians believe that market forces are unreliable and the government responds to recessions by lowering interest rates. Depressions are endemic to capitalism and it is not their severity and recalcitrance but their absence that requires explanation. Hayekians believe that the government is unreliable and the market responds to unnaturally low interest rates with an attack on the currency which provokes a recession. But, since interest rates come back down as soon as the threat to the currency is past, the severity and recalcitrance of the slump still requires explanation.
Observe that interest rates are now at historic lows and yet few people are buying houses because they cannot qualify. This is very frustrating for the Fed, who had hoped that lowering interest rates would have done more to boost the economy.

Obviously, they have not studied axiomatic economics or they would have known that interest rates are unimportant, it is credit limits that affect the business cycle.
 

phattonez

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Interest rates are determined by a central bank, or if there is no central bank, determined by savings rate and the amount of capital lent. :)
 

drz-400

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The answer is either a or b depending upon whether there is a demand or supply shock. If there is a supply shock, a central bank could lower interest rates to fight unemployment or raise interest rates to fight inflation.
 
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