Federal Reserve and uncertainty

Great Debates
1

I’ve been thinking about the Fed, and I’m starting to think that it’s a hell of a way to run a railroad. I’m not talking about any particular decision, but instead the method by which they affect the economy. Bear in mind that I did dismally in Econ in school, and if I am butt-talking, please be kind.

I have two issues/queries:

  1. Stability - in the past six months there have been, what, seven cuts to the fed funds rate. Certainly, the Fed knew that when it made the first .5% cut, more would be needed. Under economic theory, wouldn’t it make more sense to make all the cuts at once, thereby giving the markets the longest possible period of stable rates, so that business can make long-term plans? Overall, isn’t the fact that rates rarely remain stable for long harm long-term planning?;

  2. Anticipation - to simplify, the Fed increases rates when inflation threatens, in order to make borrowing more expensive and thereby dampen demand, and lowers rates when recession threatens, in order to make borrowing less expensive and thereby encourage demand. But moves by the Fed are very often telegraphed and/or are obvious ahead of time. If I’m a businessman and I think rates are going to go down, I would hold off borrowing until they did, and I would borrow as soon as possible if I thought rates were going to go up. Under these circumstances, the anticipated rate change would have the opposite effect - at a time when demand is too high, people are borrowing quickly, and at a time demand is sputtering, people are holding off on borrowing. This doesn’t seem good.

Any thoughts on fixing this? Or, if I’m dead wrong, a quick lesson on how the Fed works, please.

Sua

2

Well you see…

They are part of the Masonic trilateralist United Nations conspiracy to take over the world. They have been trying to kill this country since Woodrow Wilson had to create them as part of his pact with the devil to win WWI.

Ignore America’s rise to power over the last 100 years.

They caused the great depression and they put a pyramid with an all seeing eye on our money.

Those bastards.

3

Seriously, Larry Kudlow on CNBC said somewhere along the way that business does better when the Fed is done with a rate campaign.
Don’t know if it’s true, but it certainly sounds plausible.

And the Fed put that all-seeing eye there? Was that before or after Greenspan started wearing glasses? And were they fans of Dr. Strange?

4

I have a degree in econ but it’s getting pretty old. Did 10 years with international investment banks and worked closely with their economists. I still write strategy and advise people on China investments, but I don’t call myself and economist. There are a couple of real economists on the board, so feel free to correct any errors.

The Fed under Greenspan has become much more open. Prior to Feb 1994, the Fed did not announce changes to the interest rates (actually the Federal Funds rate), but just did the change and let borrowers figure it out. Generally, speaking the Fed cuts rates at a FOMC (Federal Open Market Committee) meeting, although there have been a few execptions including one this year.

Greenspan also makes very considered public comments, has to testify in front of Congress twice a year (Humphrey Hawkins), the other Fed governors make all sorts of public statements, IIRC you can also get the minutes of FOMC meetings. Upshot of all this is that the Fed is relatively open these days. One can hazard a reasonable guess as to what the Fed is looking for, hoping to accomplish and what they will do.

To put it simplistically, I think Greenspan has two overriding goals: to keep inflation at bay and create a macro environment that supports sustainable real growth. If you remember back to the late 70’s/early 80’s inflation was a real problem with Tbills peaking around 19%. Now the 10 year is at 5.35%.

For the past year, the economy has been slowing. The Fed has been cutting interest rates aggressively with the majority of indicators showing no signs of inflation. I believe that as soon as inflationary signs start cropping up the Fed will be pushing rates up as fast as they came down. If you pay attention to the FOMC analysis in the press, there is always talk of whether or not there are signs of inflation.

SuaSponte, by an amazing coincidence Bloomberg has a piece that is quite relevant here (http://www.bloomberg.com/feature/feature994457536.html).
“short-term Treasury yields are rising at a time when the Federal Reserve is attempting to drive down rates. To some extent, that’s ameliorated the benefits of the Fed’s six interest-rate reductions this year. The longer-term effect is on the bond market’s perception of government borrowing trends. Investors and traders are getting antsy about prospects for a budget surplus many fear is dwindling before their eyes.”

Stability – The goal is to make a rate change, and hope that the knock on effects filter through to the economy and everything is hunky dory. Please remember that the full effects of a rate cut IIRC take at least 6 months to filter through to the economy. Again, IIRC a fiscal cut like cutting taxes takes at least 12 months.

For example, last year when rates were getting raised, if the Fed turned around and suddenly did a surprise 300 basis point cut, that would cause instability. It would actually put borrowers and lenders into a panic.

By announcing a rate change, and the reasoning why, borrowers and lenders can then make plans for the future, how to hedge, policies they will enact.

Actually rates have been pretty steady the past few years, IIRC +/-300 bps.

Anticipation: well, the Fed made the decision to be more open. We live in a free market, so people will anticipate Fed moves. There are winners and losers throughout society. For example, do I refinance my house now or wait 6 months hoping rates will go lower? Since rates affect everyone, I think the Fed being open levels the playing field in that more average people understand what the Fed is doing. This is a good thing.

Regarding your post, see if the Fed raises rates 25 basis points and “everyone” thinks that really it will be 100 basis points before the Fed is finally finished raising rates. “Everyone” rushes out to borrow at the current cheaper rates. This increases borrowing demand, and lenders reduce the amount they want to lend at this level because they think the Fed will raise more rates. Borrowers are willing to borrow at a higher rate and lenders willing to lend. Wave a magic economic wand, the Fed only raised rates 25 basis points but the effect on the economy was maybe more like 75 basis point raise. 75 basis points is enough to cool the economy.

Hope this makes some sense and helps to answer your question. Otherwise, you need to find a one handed economist.