In order to understand the business cycle--the cycle of economic boom and bust--one must first understand the role interest rates play in coordinating production across time.  When consumers show a general preference to spend less in the present and to save, banks have more money the lend, and therefore, interest rates will be lower.  This serves as a signal to businesses that it would be a good time to undertake costly, time-consuming projects to expand capacity for future production.  When consumers show a general preference to spend in the present rather then save, banks will have less money to lend, and therefore, interest rates will be higher.  However, interest rates can only coordinate production across time in such a manner if they are allowed to fluctuate freely in response to consumer demand and preferences.

Enter the central bank.  It can be shown historically that the natural tendency of central banks and the state is to inflate the currency or to expand the amount of credit available in a society.  In the case of the United States, the Federal Reserve--via its open market operations, its setting of reserve requirements, and its control of the Federal Funds Rate and the Discount Rate--is able manipulate interest rates.  When the Federal Reserve artificially forces down interest rates by expanding the money supply, a mismatch of market forces occurs.  Interest rates have been lowered when consumers have shown no preference to save in the present and spend in the future.  As a result, forecasting errors on the part of businesses and individuals occur.  Projects that appear to be profitable at the time are undertaken, driven on by cheap credit.  For a time the economy appears to be doing well--new construction is being undertaken, businesses are expanding their production capacity, etc.  However, the economy is essentially on a "sugar-high."  Many of these projects will turn out to be unsustainable.

Pressure will build for the liquidation of these unsustainable projects and unwise investments.  Here we see the bust following the boom.  At this point, the Federal Reserve can continue its monetary inflation (as it often does) in an attempt to keep the boom going.  Also, the state will often attempt prop up failing markets via emergency loans and bailouts; however, this will only make economic recovery a longer process.  At some point the brakes must be applied to the Federal Reserve's monetary inflation; otherwise, runaway price inflation can occur, destroying the value of the monetary unit.

This understanding of central banks' role and the business cycle explains many economic crises--the Great Depression, and collapse of the tech bubble, and the recent collapse of the housing bubble and the resulting mortgage crisis.