Central Banks can influence to federal funds rate, overnight lending rate of depositary institutions to another depositary institutions, this would indirectly influence to lending rate of banks. The Federal Reserve of the U.S kept interest rate below 2.5% from 2001 to 2005, the results were as expected: borrowings of consumers, speculators and homeowners started growing at high pace. For example, households borrowed $4.4 trillion in total including mortgage and other types borrowings.
Cost of borrowing was too low, the U.S economy was flooded with cheap money, consumers were spending more than they earned. Corporation were taking any investment with return exceeding the cost of borrowing. On the other hand, speculators were investing in stock with return exceeding cost of money. The lower interest rates allowed refinancing of mortgage loans, the burst of housing bubble cause by excessive investing and irrational behavior have caused the bubble.
As governor of the Fed, Mr.Greenspan kept interest rate low and encouraged irrational behavior in stock markets and corporate management.
Mr. Greenspan is putting blame on regulators. I wanted to state his own words.
"Risks in financial markets, including derivatives markets, are being regulated by private parties," Greenspan said on Capitol Hill 1994. "There is nothing involved in federal regulation per se which makes it superior to market regulation." Nevertheless, Mr.Greenspan is playing another "song" now, I guess someone has to remind his point of view 15 years ago, which caused current global financial crisis.
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