I think you've got your years mixed up. Had Greenspan not hiked rates too high, and been so slow to correct his mistake, then rates never would have been lowered to 1%.
In our current situation, the damage has already been done. Lowering rates now isn't going to change that. The longer the Fed waits, the more it's going to have to lower rates in the future. It's like the mechanic says, you can pay me now or you can pay me later.
In a credit crunch you want more inflation. So thats simple lower the rates right? Well its not so simple. Because first off it may only slightly increase borrowing having rates lower by a percent. Do tons of new projects suddenly become viable at 4% interest versus 5%? Probably some do, but the number may not be that high. And investors may demand a higher spread anyway to compensate.
The big problem is the more companies limp along but dont’ die.. the more they are paying off debt + interest. So imagine GM with lets use 160 billion in debt for arguments sake. If GM goes bankrupt, its assets are auctioned for say 20 billion, and the first in line creditos get their money.
Then the next 140 billion is gone. And probably all the leveraged garbge borrowed on top of that. But lets just use 140 billion. So then that debt is simply written off. Which means that 140 billion stays circulating in the economy.
Meanwhile if it needs to be payed back, even at 2% interest.. each payment that ends up at the fed removes that money from the money supply. + the additional 2% interest disappears from the money supply. Meaning someone else, somewhere in the economy has to borrow that same amount of money to get it back into the money supply. Say they payed off even 5 billion of it one year.
If companies are paying even just the interest on a mountain of debt they borrowed in the past, that money is disappearing from the economy. And it seems unlikely they are going to borrow new money at this point in time regardless of the interest rates. Afterall we see across this economy oversupply. Too many auto plants.. too many McDonalds and strip malls, etc.. Which is the typical outcome of a credit bubble.
Ironically if we lower rates just enough to keep up these walking half-dead companies, the amount of dollars could shrink. Causing deflation! The dollar could actually rise against foreign currencies in that situation. Well I admit I could be wrong on my evalution of the market, but I know one thing Bernanke has some very difficult decisions on his hand!