Monetary policy is not universally accepted as a paleative for all economic ills. One key issue is whether low interest rates, say 0.5%, encourage people to buy capital goods when the economy is in recession. At such times, many people are working to pay down their debts and reduce their monthly expenses. In contrast, during economic boom periods low interest rates undoubtedly encourage incremental spending.

The conundrum facing the Federal Reserve System is when to put its foot on the gas and when to take it off. Last week Chairman Bernacke indicated his feelings that without a longer period of low interest rates that he felt that the U.S. economy was not likely to create a sufficient number of new jobs. Hence, Bernacke plans to maintain the low interest rate environment going into late 2014.

The unintended consequence of previous low interest rate periods have been a number of asset bubbles. These arise because the Fed is uncertain when to relax its expansionary monetary policies and as a result keeps them on too long. Arguably the housing bubble that ended in 2007 and the Internet stock bubble that ended in 2001 arose, at least in part, as an unintended consequence of Federal Reserve low interest rate policies.

The rush to risk being experienced on the stock market in the past 6 months can be explained as the persistence of a belief that the Fed will overstimulate the economy. In other words, people are expecting further unintended consequences. This hypothesis is consistent with the rational expecations view of the word that says that after being fooled once people revise their beliefs and expecations to avoid getting fooled again.