One of the biggest distortions in the market caused by statists, among many, is allowing the Federal Reserve and its unelected minions to arbitrarily set interest rates. If you were to ask the average person if it was a good idea to allow some government bureau of academics and wonks to set the price of smartphones, toilet paper, or canned peaches in heavy syrup I would venture to say that most people would agree that this would not be a good idea. However almost no one argues with allowing the Federal Reserve to have the power to set the price of money which are interest rates. In fact the power of the Fed and the people who run it has been raised to the level of demi-god status.
Interest rates are very important for many reasons. One of the main reasons is that it is a major consideration for managers in corporations and business as to whether a project should move forward or not. If I am considering building a factory and I will be using debt to finance the factory I have to figure in the cost of debt which is the interest rate. If rates are to high the debt incurred may make my anticipated costs to high and not allow enough of a return to make the project worthwhile. Obviously interest rates are not the only determining factor that a manager would take into account when analyzing the economics of a proposed project but they are a major factor nonetheless. So what happens when the Federal Reserve artificially lowers interest rates or the cost of debt. In the case of our manager who is analyzing a proposed project the lower cost of capital would help to make his anticipated return on investment look better than it would if one was operating in an environment where normal rates prevailed. This might mean that the project is not really economic but looks good in the suppressed rate environment. It is my contention that this is how bubbles are formed in the economy.
The Federal Reserve reacts to a weakening economy or financial crisis by lowering rates well below the market rate and floods the economy with liquidity. These actions by the Fed are price signals and economic actors react by borrowing money and doing things with that money which leads to much uneconomic activity taking place ie the tech bubble in the early 2000's and the real estate bubble in 2007 which led to the financial crisis. These bubbles which will always collapse as they are dependent on cheap credit from the Fed collapse when the Fed pulls back from its lower rate policy. It has been suggested that the recent stock market gains over the last few years are nothing but the result of Fed cheap money policies. John Hussman had a recent article that talks about this issue and its previous results. Two quotes from economists Hayek and Von Mises in Mr. Hussman's article are relevant: