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When demand for liquidity outstrips supply (rate increase in a credit crunch) then the law of supply states that quantity supplied also increases with price (rate decrease provided demand stays constant). That’s what central banks do so where’s the manipulation there?

  • Interest rates are a key link in the economy between investors and savers, as well as finance and real economic activity.

  • Markets for liquid credit function just like other types of markets, according to the laws of supply and demand.

  • When an economy enters a recession, demand for liquidity increases while the supply of credit decreases, which would normally be expected to result in an increase in interest rates.

  • A central bank can use monetary policy to counteract the normal forces of supply and demand to reduce interest rates, which is why we see falling interest rates during recessions.

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    $\begingroup$ 1. Can you please support your claim "so many economists critical of central banks manipulating markets and creating artificial demand" with academic references? There are a lot of economists, so many of us will do silly things on any given day. $\endgroup$
    – Giskard
    Aug 4 at 20:04
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    $\begingroup$ 2. "That’s what central banks do" What exactly does "that" refer to in this sentence? $\endgroup$
    – Giskard
    Aug 4 at 20:04
  • $\begingroup$ “That” refers to the process of providing supply (credit) in a market that faces growth in demand and price (interest rates). $\endgroup$
    – ThomasJ
    Aug 4 at 20:11
  • $\begingroup$ @ThomasJ could you please provide support for the claims you are making as requested by giskard $\endgroup$
    – 1muflon1
    Aug 5 at 11:15
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The question is:

Why are so many economists critical of central banks manipulating markets and creating artificial demand?

But, as you said:

Markets for liquid credit function just like other types of markets, according to the laws of supply and demand.

The interventions of the central bank may hamper the capacity of the credit market to function as you described. Interest rates do not function as a price anymore. Therefore, they will distort intertemporal decisions. Besides, the new money created does not reach firms uniformly, and this creates distortions in relative prices.

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  • $\begingroup$ Quite a helpful response, thanks! I am just a bit confused about the statements made by many which claim that central banks are distorting the natural forces of supply and demand by injecting liquidity. I don’t see how that’s the case if there’s actual demand for that liquidity that’s causing rates to increase (e.g. in the case of a credit crunch). It only makes sense to me that if rates rise then the quantity of credit supplied should increase with everything else kept constant. At least that’s what the natural law of supply asserts. $\endgroup$
    – ThomasJ
    Aug 4 at 22:33

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