NationStates Jolt Archive

http://money.cnn.com/2007/10/31/news/economy/fed_rates/index.htm?postversion=2007103116
http://money.cnn.com/2007/10/31/news/economy/fed_statement/index.htm?postversion=2007103114

For those with no training or knowledge of this: the Federal Reserve prints US Dollars. It then exchanges those dollars for bonds both directly with the government and in the market, to regulate how much money private banks have to pour into the general economy. Put extremely simply, the interest rate is the price of money, so if it gets cut, that means there is more money around.

The hope is twofold: firstly, with more money people hopefully buy more stuff. Secondly, with lower interest rates, people can get bigger loans to make buy machines and stuff with.

So when the Fed cuts rates, it's trying to get the economy to run a little faster.

This time the reason is of course that the US housing market doesn't look like it's getting better, and Bernanke is worried that this might make people stop buying stuff, thereby causing a recession. However, as the articles suggest, there is some risk that the cuts might cause inflation.

In Australia on the other hand, the Reserve Bank is only concerned with inflation. It's got a fairly tight target (2-3%), when inflation goes above that, it will raise interest rates, if it falls below, it will cut them. It does not make decisions based on other economic variables, like unemployment or current account deficits.

That way a lot of uncertainty is taken out of the equation. There is one target (inflation) and one tool (interest rates). Markets (and consumers) can anticipate rate changes with some certainty. The bonus is that people's expectations don't change rapidly - because the effect of an interest rate cut depends largely on whether it actually changes people's behaviour, which in turn is depends on their expectations for the future.

In the US they have traditionally tried to manage expectations by appointing fairly conservative central bankers. However, these guys are given an almost entirely free reign. They are obliged to care about inflation, but they also react to other stuff quite frequently (like they do right now). And as a tool to manage the market's expectations about future policy they give cryptic statements which people then have to interpret.

Which system do you think is better? Should the central bank be tied to combating inflation and discouraged from caring about anything else? Should there be clear-cut rules on when it acts and what it does?

This rate cut was one of those things that's difficult to determine right now. GDP was incredible, coming in at a strong 3.9%, but it was also combined with a very low inflation reading that suggests an additional rate cut is possible without stoking inflation. However, given the fact that commodities look like they're blazing in to a bubble, this might be little more fuel for the fire just like the rate cut in 1999 caused the NASDAQ to explode through 4,000 and then 5,000 in a couple of months before bursting.

I don't think the risk of recession is very high; construction spending came in a lot better than expected, nonresidential and public building is offsetting the housing decline, and consumer spending is being bolstered by strong real growth in wages and salaries. Really, the housing correction and subsequent bear market seem more like an issue of consumer confidence than a major threat to the economy.

I personally support a steady growth rate in the money supply because it keeps inflation expectations constant and minimizes the effects of policy-driven unexpected inflation on the economy.

Cryptic is the absolute perfect word to describe how Fed Chairman speaks to the public.

Although, I think the concerns about the housing market are fairly justified, and while inflation is a concern, Bernanke's pedigree would lead me to think that if it becomes a major problem, he'll be able to catch it fairly early on. Rate cuts can help us ride out economic storms, but they need to be used sparingly, lest we start to find ourselves feeling that seventies inflatory malaise once again.

A better example of a nation with a strict inflation target is the pioneer of inflation targeting, New Zealand. Here, the Reserve Bank Governor is contractually required to keep inflation between 1 and 3 per cent over the medium term - if he breaches those boundaries for too long, then he is sacked.

My personal opinion is that strict inflation targetting is probably the best option. If you try to get the Reserve Bank to look at other measures such as economic growth and employment, then you will be just causing issues: you generally cannot have massive economic growth and very low unemployment without causing some inflation.

My own feeling is that Bernanke may be setting himself up for failure later on. In 2003, here in New Zealand, Alan Bollard cut interest rates substantially due to fears of deflation. Not only were those fears unfounded, all it did was cause a nationwide spend up and interest rates have had to go much higher than required to tame inflation.

Anyways - lower US interest rates = higher NZ dollar = lower fuel prices

The Federal Reserve and other means of government intervention in the economy need to be abolished. The market can freely and efficiently establish the best rate without external influences.

The Federal Reserve and other means of government intervention in the economy need to be abolished. The market can freely and efficiently establish the best rate without external influences.

Laissez faire? Absolutely no controls? that's how the depression started... No regulations and too much of society's wealth concentrated in the hands of a few.

The Federal Reserve and other means of government intervention in the economy need to be abolished. The market can freely and efficiently establish the best rate without external influences.

No, it really can't. We've seen the effects of the lack of a central bank before, and it's hardly something I'd want to go back to. Given that the 20th and 21st centuries have seen only one Great Depression and a handful of mild recessions as opposed to the dozens of panics and major recessions of the 18th and 19th centuries, it's safe to say that central banking and a standard fiat currency are a recipe for continued sustainable economic growth for as long as they are managed properly.

The Federal Reserve and other means of government intervention in the economy need to be abolished. The market can freely and efficiently establish the best rate without external influences.

So where do we get our currency from then? The private sector could provide it, but imagine the thought of exchanging between different currencies every day. Also, the market does establish the an interest rate - short term interest rates would be influenced by a variety of factors, not just what the Federal Reserve says.

Laissez faire? Absolutely no controls? that's how the depression started... No regulations and too much of society's wealth concentrated in the hands of a few.
Well, there were controls. Just not very good ones.

For example, there was the one saying banks had to be small and local (to prevent monopolies). Which in effect just meant that the banks who lost on the share market weren't big enough to sustain the losses and had to close.

And on the other hand, there is some evidence that the gold standard had to do with the depression getting out of hand. So I think fiat money (if well-managed) has proven itself a pretty good system.

And on the other hand, there is some evidence that the gold standard had to do with the depression getting out of hand. So I think fiat money (if well-managed) has proven itself a pretty good system.

I'd say it's partially, if not primarily due to the fact that currency based on finite natural resources doesn't work very well with an economy that is based on exponential growth. However, since fiat money, just like knowledge or the development of new technologies, has apparently limitless growth potential, it is ar better suited to an economy based on exponential growth.

The Fed should be abolished without delay.

The Fed should be abolished without delay.

That would be a colossal economic disaster. The Fed is necessary, but it needs to embrace a monetarist view on policy in order to undo the damage it has caused alongside the prosperity it has created over the past 94 years.

The Federal Reserve and other means of government intervention in the economy need to be abolished. The market can freely and efficiently establish the best rate without external influences.

I love you.

Laissez faire? Absolutely no controls? that's how the depression started... No regulations and too much of society's wealth concentrated in the hands of a few.

No -- the Great Depression was caused (or at least exacerbated) by excessive government intervention in the economy. Have you read Milton Friedman's thesis on the matter? The market, if not tampered with, would have shortly self-corrected; unfortunately, myopic economic policies by the boys in Washington precluded this eventuality.

Also, the market does establish the an interest rate - short term interest rates would be influenced by a variety of factors, not just what the Federal Reserve says.

The interest rates established by the market are heavily reliant on the federal government's lead. It's hard to engage in refined maneuvering when you have an 800 pound gorilla in the room (the Federal Reserve). However, I do agree that a standardized currency is a necessary prerequisite for a coherent market system.

No, it really can't. We've seen the effects of the lack of a central bank before, and it's hardly something I'd want to go back to. Given that the 20th and 21st centuries have seen only one Great Depression and a handful of mild recessions as opposed to the dozens of panics and major recessions of the 18th and 19th centuries, it's safe to say that central banking and a standard fiat currency are a recipe for continued sustainable economic growth for as long as they are managed properly.

Not so. For example, the Panic of 1837 (alternatively known as Biddle's Panic) was precipitated by unwise government intervention in the economy (namely, the specie circular order issued by Jackson). Moreover, one cannot compare the hectic days of bygone centuries with the extant post-industrial economic system.

Not so. For example, the Panic of 1837 (alternatively known as Biddle's Panic) was precipitated by unwise government intervention in the economy (namely, the specie circular order issued by Jackson). Moreover, one cannot compare the hectic days of bygone centuries with the extant post-industrial economic system.

I don't disagree with the fact that those panics were almost always associated with government intervention, but it is also true those banks and currencies failed due to the lack of any real system of backing up their value or regulations on their practices.

It's also true, however, that the modern economy is a lot more globalized than it was in the past, which makes the need for stable, government-backed currencies far more important. Imagine what effects it would have on global trade if every country had to deal with hundreds, even thousands of different currencies when trading with other nations. This would create so many additional costs and delays along the way that trade would slow considerably, with devastating economic effect.

No -- the Great Depression was caused (or at least exacerbated) by excessive government intervention in the economy. Have you read Milton Friedman's thesis on the matter? The market, if not tampered with, would have shortly self-corrected; unfortunately, myopic economic policies by the boys in Washington precluded this eventuality.

Pretty much every economist believes the Fed made the sitiuation worse when it raised interest rates, but the vast majority of these people believe that the Fed should have been expanding the money supply instead. Friedman, being the founder of monetarism, believed in a central bank that increased the money supply to the same degree as the velocity of money.

I think that the Fed should try to balance low inflation with higher real economic growth if the two conflict. Unemployment should be noted but should have relatively little impact on policy changes.

I think that the Fed should try to balance low inflation with higher real economic growth if the two conflict. Unemployment should be noted but should have relatively little impact on policy changes.
The problem with that is when you end up having more than one variable to target with only one policy instrument, you end up in difficulties. I think it was Tinbergen (but I can't remember for the life of me) who found that you'll get the best results when you have one instrument per target variable and vice versa, rather than constantly having to trade off against each other*. And in the case of the central bank, the whole expectation thing is added to that.

So one would think that it would be better to have the Fed worry about inflation (and, very maybe, if there are risks of things getting out of hand, financial markets), and the government worry about unemployment, CAD and so on. The government has a bunch of fiscal policy tools that are probably just as good if not better at dealing with unemployment (eg spending, deregulation, taxes and FTAs).

*Yes, it was Tinbergen. It's based on simultaneous equations: you can't have more dependent variables than independent ones and still get a solution.

No -- the Great Depression was caused (or at least exacerbated) by excessive government intervention in the economy. Have you read Milton Friedman's thesis on the matter? The market, if not tampered with, would have shortly self-corrected; unfortunately, myopic economic policies by the boys in Washington precluded this eventuality.

Correct. I also recommend reading America's Great Depression, by Murray N. Rothbard. I think the entire book is available online, in PDF format, free of charge.

Correct. I also recommend reading America's Great Depression, by Murray N. Rothbard. I think the entire book is available online, in PDF format, free of charge.
Everybody knows that I love a good debate about right and wrong when it comes to economics.

But I'm also of the opinion that macroeconomics is not about who is right, but about what works best. That's why different schools of the discipline keep coming together and taking ideas from each other.

There's been a gigantic host of stuff written about the causes and cures for the Great Depression (Bernanke himself has written a volume or two, I believe). All of it probably has a bit of truth to it.

But the fact of the matter is that modern, western central banks have become very good at what they do and the likelihood of another Great Depression is near zero. If you want something to be worried or annoyed about, worry about the fact that global money supply seems to have become somewhat disconnected from the decisions of the ECB and the Fed, and is increasingly determined in Russia, India, Brazil and even China. And those banks are nowhere near up to the level of competence, experience or independence of the western ones.

The problem with that is when you end up having more than one variable to target with only one policy instrument, you end up in difficulties. I think it was Tinbergen (but I can't remember for the life of me) who found that you'll get the best results when you have one instrument per target variable and vice versa, rather than constantly having to trade off against each other*. And in the case of the central bank, the whole expectation thing is added to that.

So one would think that it would be better to have the Fed worry about inflation (and, very maybe, if there are risks of things getting out of hand, financial markets), and the government worry about unemployment, CAD and so on. The government has a bunch of fiscal policy tools that are probably just as good if not better at dealing with unemployment (eg spending, deregulation, taxes and FTAs).

*Yes, it was Tinbergen. It's based on simultaneous equations: you can't have more dependent variables than independent ones and still get a solution


Perhaps. I really don't know enough about the subject to debate, but I would hope that real economic growth isn't sacrificed to lower inflation. That was my main concern. Unemployment was a distant third.

Perhaps. I really don't know enough about the subject to debate, but I would hope that real economic growth isn't sacrificed to lower inflation. That was my main concern. Unemployment was a distant third.
Well, real economic growth just means growth adjusted for price changes, that is inflation.

So if you have inflation of 5% and GDP grows by 10%, then only 5% of that is real.

Whether you raise nominal growth to 14% or reduce inflation to 1% doesn't make much of a difference, people end up with more buying power either way.

Except that inflation plays havoc with people's expectations and creates a lot of uncertainty. On the plus side, if you've got a big loan and interest payments denoted in nominal dollars, inflation isn't so bad.

Well, real economic growth just means growth adjusted for price changes, that is inflation.

So if you have inflation of 5% and GDP grows by 10%, then only 5% of that is real.

Whether you raise nominal growth to 14% or reduce inflation to 1% doesn't make much of a difference, people end up with more buying power either way.

Of course. I am just wondering whether one could have higher real economic growth at higher inflation a rate, which means thw nominal growth rates is higher still. If not then there is no problem.

Of course. I am just wondering whether one could have higher real economic growth at higher inflation a rate, which means thw nominal growth rates is higher still. If not then there is no problem.

Rising inflation and rising growth rates usually mean overheating, which is not a good thing by any stretch. It will correct at some point and usually more severely than if inflation was kept under control.

First of all, I am one of the minority of those that believe that the Great Depression was caused by the Smoot Hawley Tariff Act; the law was being debated in the Senate as the Wall Street Crash of 1929 occurred and the economy went into a nose dive the minute it became law (if you look at the Dow Jones Industrial Average, it went from 380 to about 270 in 1929, then climbed up above 300 again in 1930, then suddenly dived in 1931 and 1932 to 80).

Also, while I do not dispute that the Federal Reserve may be a ten ton gorilla in the room, there are other factors that determine market interest rates in a modern environment; the interest rates of Japan, the PRC and the European Union would influence market interest rates. Even overall confidence in the economy can influence market interest rates; New Zealand for example saw a .75% hike in the 90 day Bank Bill rate in September due to a loss of confidence - this without any Reserve Bank intervention.

First of all, I am one of the minority of those that believe that the Great Depression was caused by the Smoot Hawley Tariff Act; the law was being debated in the Senate as the Wall Street Crash of 1929 occurred and the economy went into a nose dive the minute it became law (if you look at the Dow Jones Industrial Average, it went from 380 to about 270 in 1929, then climbed up above 300 again in 1930, then suddenly dived in 1931 and 1932 to 80).

I share the same opinion. In fact, I'd go so far as to say all of the protectionist policies of the 1920's led to the Depression, with the Smoot-Hawley Tarriff Act being the last straw that caused the markets to finally break. It led to such huge structural problems in the world financial markets that it had to eventually break, and it did in quite spectacular fashion.

The idea of the Fed is fine, but the idea that it is a body unaccountable to the people is not.

On the plus side, if you've got a big loan and interest payments denoted in nominal dollars, inflation isn't so bad.Indeed. It is deflation that is more worrisome.

You know, given the limited resources of this planet and how we've pushed them to the brink already, wouldn't it make more sense to go for economic sustainability rather than pure growth growth growth all the time, at least till we have some sort of way of expanding fully beyond this one planet?

Well that went poorly.

Predictably though.

ROFLMAO

More OH SHIT...deflation usually means something has gone terribly wrong at some point in the economy.

Indeed. It is deflation that is more worrisome.

ROFLMAO

More OH SHIT...deflation usually means something has gone terribly wrong at some point in the economy.

Why?

Why?

Because deflation almost always occurs due to depreciation exceeding the marginal product of capital per worker; when that happens, that means per capita output also falls, unemployment rises, and real wages fall. All in all, it's not a good thing. Most of the deflation in the past has been due to similar economic declines; the Long Depression in Europe, the Panics of 1896, 1907, et al in the US, the Great Depression...deflation is usually a sign of severe long-term systemic problems in the economy.

I mean, look at Japan...a decade of stagnation and rising unemployment following the bursting of the Nikkei and asset bubbles.

Because deflation almost always occurs due to depreciation exceeding the marginal product of capital per worker; when that happens, that means per capita output also falls, unemployment rises, and real wages fall. All in all, it's not a good thing.

I mean, look at Japan...a decade of stagnation and rising unemployment following the bursting of the Nikkei and asset bubbles.

If prices fall, real wages rise.

If prices fall, real wages rise.

Not necessarily. Wages are falling alongside prices because workers are being laid off, driving up unemployment and the supply of available labor. People are so desperate for work that they are willing to accept less, and less, and less until the market balances. The end result is a fall in real wages.

That's not always the case (see the US during the 1870's-1890's, when it benefited from the deflation caused by the Long Depression in Europe), but these benefits are far and few between.

Because deflation almost always occurs due to depreciation exceeding the marginal product of capital per worker; when that happens, that means per capita output also falls, unemployment rises, and real wages fall. All in all, it's not a good thing. Most of the deflation in the past has been due to similar economic declines; the Long Depression in Europe, the Panics of 1896, 1907, et al in the US, the Great Depression...deflation is usually a sign of severe long-term systemic problems in the economy.

I mean, look at Japan...a decade of stagnation and rising unemployment following the bursting of the Nikkei and asset bubbles.

Thing of it is though, trends are really deflationary. Stuff is cheaper than it was ten years ago - in general. Minimum wage in 1950 got you a lot less than minimum wage today.

People are just to pessimistic about the overall state of affairs. Generally things are in an uptrend. It's been a long term super-secular bull since the fourteenth century.

Thing of it is though, trends are really deflationary. Stuff is cheaper than it was ten years ago - in general. Minimum wage in 1950 got you a lot less than minimum wage today.

People are just to pessimistic about the overall state of affairs. Generally things are in an uptrend. It's been a long term super-secular bull since the fourteenth century.

I agree 100%. It may be likely that the conventional wisdom regarding inflation and deflation will need to be rewritten as technology advances and it begins to affect the economy at a deeper and deeper level than ever before. Deflation may become a normal state of affairs as the primary causes of inflation are offset by deflationary factors.

I agree 100%. It may be likely that the conventional wisdom regarding inflation and deflation will need to be rewritten as technology advances and it begins to affect the economy at a deeper and deeper level than ever before. Deflation may become a normal state of affairs as the primary causes of inflation are offset by deflationary factors.

I think so. The entire national output of the US in 1928 couldn't buy the equivalent of my car. It just didn't exist. There has been massive wealth creation since the industrial revolution that people just don't have a handle on.


For example, for lunch today I had tuna flown in from japan. The richest plutocrat in the world one hundred years ago couldn't have done that. And I am just a normal person today.

Well, deflation is not always that bad; look at the period of 1815 to 1939 - you had absolutely no movement in prices: each period of inflation was offset by a period of deflation. While the deflationary periods were painful, you had massive growth during that period economically. Also, with regard to Japan, while it may be having minor economic problems, an economics lecturer from my University suggested that some first world nations would pay to have Japan's economic problems!

I would myself love to go back to the days when a pint of milk cost 4 cents, you could get your daily paper for 3 cents and you earnt $40 a week, and when your money was backed with real gold and your coins even had real silver in them.

I would myself love to go back to the days when a pint of milk cost 4 cents, you could get your daily paper for 3 cents and you earnt $40 a week, and when your money was backed with real gold and your coins even had real silver in them.

I wouldn't, simply because I know it would end painfully every time. Really, things are better than they've ever been, from the perspective of the world economy.

What do you think of investing in foreign CD's? Generally they have a higher rate of return coupled with the dollar decline they could have double digit returns.

I wouldn't, simply because I know it would end painfully every time. Really, things are better than they've ever been, from the perspective of the world economy.

Absolutely true. Funny how a lot of people are gloom and doom.

Also this came up in a conversation I was having with a business partner the other night. What in your guys opinion would be the benefit and reward of the US paying off it's national debt? In your opinions would it give a unprecedented upward swing in the US economy or would a rising dollar kill any such move?

Also this came up in a conversation I was having with a business partner the other night. What in your guys opinion would be the benefit and reward of the US paying off it's nation debt? In your opinions would it give a unprecedented upward swing in the US economy or would a rising dollar kill any such move?

I think paying off all of the debt would be undesirable, since US bonds are a very stable and very good investment; they provide a secure investment that is indispensable to the global financial system. It would also mess with monetary policy a little bit by making open market operations more difficult.

Reducing the deficit to a stable level, say 25% of GDP (a random figure, but you get my point), would probably be more desirable than paying off the debt.

What do you think of investing in foreign CD's? Generally they have a higher rate of return coupled with the dollar decline they could have double digit returns.

Which ones? Short term I would recommend the Norwegian Krona and the Swiss Franc. In general the US is on the wrong side of the interest rate curve. I'm ambivalent about the Euro and Sterling. The Aus$ and the NZ$ are big beneficiaries of the carry trade so probably best to stay away from them;
despite their rates of return. Better off just hitting the Yen, which is their underlying strength.


But if you want at good punt. I would look for the HK$. There are rumors that it might decouple from the US$. Highly speculative, of course, but could pay big if you can cover the FOREX margin through intermediate losses.

(Then again you could be pantsed).

As always, do your own DD.

I think paying off all of the debt would be undesirable, since US bonds are a very stable and very good investment; they provide a secure investment that is indispensable to the global financial system. It would also mess with monetary policy a little bit by making open market operations more difficult.

Reducing the deficit to a stable level, say 25% of GDP (a random figure, but you get my point), would probably be more desirable than paying off the debt.

I think the Fed's action has clearly signaled a bias towards a lower interest rate environment. I've taken some tasty profits off intermediate and long bonds this summer, and I still think there are more to come.

Bonds are one whole order of magnitude of difficulty compared to equities though. So if you can't figure out why that is true, stay away from them.

Bonds are one whole order of magnitude of difficulty compared to equities though. So if you can't figure out why that is true, stay away from them.

I'm studying bonds currently for my Econ 520 course...they are definitely a world apart from equities. They're also exceptionally complex to value in comparison.

I'm studying bonds currently for my Econ 520 course...they are definitely a world apart from equities. They're also exceptionally complex to value in comparison.

Well yes. I only play treasuries, because the only real mispricing there is interest rate risk.

Corporates are more complex than options IMO however. Most people will disagree but that is what I have found. I think the ABX agrees with me on that point though.

Not necessarily. Wages are falling alongside prices because workers are being laid off, driving up unemployment and the supply of available labor. People are so desperate for work that they are willing to accept less, and less, and less until the market balances. The end result is a fall in real wages.

That's not always the case (see the US during the 1870's-1890's, when it benefited from the deflation caused by the Long Depression in Europe), but these benefits are far and few between.Not to mention that loans that people take out prior to the deflation have to be paid back.
This wouldn't bode well for our credit-based economy.