Most experts agree that through the manipulation of short-term interest rates, the central bank by means of expectations regarding future interest rate policy can also dictate the direction of long-term interest rates. On this way of thinking expectations regarding future short-term interest rates are instrumental in setting the long-term rates. (Note the long-term rates are an average of short-term rates on this way of thinking).
Given the supposedly almost absolute control over interest rates, the central bank by correct manipulations of short-term interest rates could navigate the economy along the growth path of economic prosperity, so it is held. (In fact, this is the mandate given to central banks).
For instance, when the economy is thought to have fallen below the path of stable economic growth it is held that by means of lowering interest rates the central bank could strengthen aggregate demand. This in turn will be supportive in bringing the economy onto a stable economic growth path.
Conversely, when the economy becomes “overheated” and moves onto a growth path above that which is deemed as stable economic growth, then by lifting interest rates the central bank could slow the economy back onto the path of economic stability.
But is it valid to suggest that the central bank is the key factor in the determination of interest?
Individuals time preferences and interest rates
According to great economic thinkers such as Carl Menger and Ludwig von Mises interest is the outcome of the fact that every individual assigns a greater importance to goods and services in the present against identical goods in the future.
The higher valuation is not the result of capricious behaviour, but because of the fact that life in the future is not possible without sustaining it first in the present. According to Carl Menger,
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