Hi, I'm doing my bachelor thesis about business cycles, and I have one question for you.
This is quote from wikipedia:
The government's attempt to gain control over money (through the creation of a central bank) destroys the natural equilibrium of interest rates between savers and borrowers. Austrian School economists conclude that, if the interest rate is held artificially low by the government or central bank, then the demand for loans will be higher than the actual supply of willing lenders, and if the interest rate is artificially high, the opposite situation will occur. This pricing misinformation leads investors to misallocate capital, borrowing and investing either too much or too little in long-term projects. Periodic recessions, then, are seen as necessary "corrections" following periods of fiat credit expansion, when unprofitable investments are liquidated, freeing capital for new investment.
(bolding is mine)
So my question is quite simple. If there are natural rate of interest (which is determined by the supply and demand of money) and in some society, let's say, that would be 5% and central bank would loan money at 15%...wouldn't central banks interest rate be then totally irrelevant (and then doesn't affect on anything) if its higher than natural rate of interest? I mean banks would prefer to borrow money at some other sources than from central bank...
No, because then you might have monetary contraction due to the deterioration of money. In a free market, where money is backed by hard assets like gold or silver, the monetary supply expands with the expansion of demand for money. This prevents significant deflation and significant inflation from occurring. However, when money is artificially taken away from the economy, you're creating a situation that reduces the amount of loans being made due to an artificial scarcity of money.
Mises Community Natural Rights Discussion Group
Your question is, "why would banks borrow at the central bank rate of 15% if the natural interest rate (determined by availability of loanable funds) is 5%"? It is important to realize that the key interest rate the central bank targets is not the rate at which they lend directly to banks, the discount rate, but rather the rate at which banks lend to each other, the federal funds rate. The way you phrased your question is suggestive of the discount rate, when really the central bank no longer relies on it in implementing their monetary policy anyway.
Rather, the central bank targets (but doesn't directly control) the federal funds rate by either pumping money into the economy of taking it out. In a sense, the central bank is very much aware of the natural laws of supply and demand for money and how they affect interest rates. So, in order to keep interest rates high in general (as in your hypothetical example) they don't try to defy the laws of supply and demand by simply declaring a certain rate, instead they manipulate the supply and demand of money itself, until the rate reaches the desired target. (Some claim that diamond companies do something similar in artificially keeping diamond prices high by withholding supply from the market.)
Now increasing or decreasing the money supply will affect various interest rates in varying degrees and with varying delay. If the money supply were suddenly cut in half, then there would probably be an immediate and dramatic impact to the federal funds rate (the rate at which banks lend to each other) while effects on mortgages would take a little longer and on consumer credit even longer than that. So, the Fed has decided on the federal funds rate as their "barometer" of whether their monetary policy is producing the desired effect. That is the rate that they target. Other central banks target different rates.
The mechanics of how they add or remove money from the economy is a little more involved. In general, they either buy assets in the marketplace, by writing checks against nothing, in order to increase the money supply, or they sell assets to the marketplace and essentially destroy the money they are paid for it.
I highly recommend Rothbard's Mystery of Banking. It is available in PDF for free from Mises, but the hardcover is hard to beat!
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