1.  The central bank forces interest rates down, below free market levels, typically by expanding the money supply

During and after World War I, the Fed inflated the money supply substantially, roughly doubling it^‡.

Between July 1921 and July 1929 the Fed increased the money supply by 55% (an average annual rate of 7.3%).

The Fed expanded the money supply by 52% between June 1995 and March 2000, at a time when real GDP growth was only 22%.

In order to bring about the artificially low target federal funds rate set by Fed chairman Alan Greenspan in the wake of the dot-com bust, more dollars were created between 2000 and 2007 than in the rest of the republic's history.

2.  Since the interest rates are lower because of artificial causes, business projects cannot all be completed.  The necessary resources to complete them have not been saved by the public.  Investors have been misled into production lines that cannot be sustained. 











                                          

When the Fed finally began raising the discount rate, the economy slowed as it began its readjustment in line with Austrian business cycle theory.  By mid-1920 production had fallen severely and continued to fall by 21% over the next year.  Conditions were worse than they would be in 1930, after the first year of the Great Depression.








                                          

Capital and titles to capital were bid up to such high prices using cheap credit that  businessmen eventually realized their investment plans could not be completed profitably.  A massive sell-off of capital began, sparking the stock market crash of October 1929.










                                          

The capital goods being purchased by the Internet and tech companies proved to be unexpectedly scarce and thus unexpectedly high in price.  At the same time that businesses were investing heavily for the future, consumers were saving less and spending more on present consumption.  The American savings rate was negative by the year 2000 and households' outstanding debt was hitting all-time highs.  The necessary resources to complete the investment projects were therefore not being released, creating an unsustainable mismatch.
                                          

In the expectation that housing prices would rise indefinitely, many homeowners bought more house than they could afford and took out home equity loans to finance increased consumption.  Enormous resources were misdirected into home construction.  But there were only so many $900,000 homes that the public, which had been saving very little, was in a position to buy.






                                          

3.  In order to recover, the market must shake out the malinvestments and redirect misallocated resources into sustainable lines. The government can either allow the market to correct itself, or it can impede recovery through spending, regulation, and/or monetary manipulation.

The government did almost nothing in response to the resulting depression.  Unemployment was 11.7% in 1921, but it fell to 6.7% in 1922 and to 2.4% in 1923.  There was a rally in business production and employment that was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise.  The depression had been the sharpest ever encountered, but it only lasted a year.

The Fed tried to inflate the boom back into existence by pumping new money into the banking system, but banks refused to lend it out.  The federal government then sought to prop up commodity and consumer prices rather than allow them to fall to a level that made sense in light of economic conditions and people's valuations of the goods and assets.  Short-selling was attacked, speculators were condemned, emergency lending was extended to firms in trouble, and salvation was sought in Hoover's public works programs and their continuation in FDR's New Deal.  The depression lasted for 10 years, ending in 1939.

Fed chairman Alan Greenspan tried to reignite the economy through a series of rate cuts, culminating in lowering the target federal funds rate to 1% for a full year, from June 2003 to June 2004.  The next bubble, this time in real estate, was thus enabled.

Congress and the Bush and Obama administrations have not allowed the market to set housing prices where they obviously belong.  Fannie and Freddie have propped up housing prices by giving assistance to homeowners who bought more houses than they could afford.  The Treasury has pushed down mortgage rates in order to make housing “more affordable” rather than just letting home prices fall to more affordable levels.  Emergency lending has been extended to firms in trouble.  In late 2008, Fed chairman Ben Bernanke brought interest rates down almost to zero.