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How the Fed Causes the Business Cycle.

In a free market, interest rates are set by supply and demand. If there are a large numbers of savers, the banks adjust their rate paid to lenders down and as a result can offer rates to borrowers at a low level. If there is a relative reluctance to save, banks will try to attract lenders by offering a higher interest rate. The higher rate forces banks to charge a correspondingly high rate of interest to borrowers.

The free market balances the supply and demand for the desire to hold the money. The meeting point is the natural interest rate. The banks don't care what the rate is. They make money on the relatively narrow spread between the lending and borrowing rates. Their real profit comes from lending more money then they take in through the magic of fraction reserve money creation. Continued here: http://www.freemarketfan.com/2011/10/how-fed-causes-business...