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I got mine, you mean y'all didn't get yours?
Posted on 05/17/2006 8:44:19 AM PDT by Marxbites
On Wednesday May 10, Federal Reserve policy makers raised the federal funds rate target by 0.25% to 5%. This was the 16th increase in the target since June 2004 when it stood at 1%.
The statement issued by Fed Chairman Bernanke and his colleagues suggested they would now pause in the cycle of interest rate increases. They say that they must assess the implications on economic activity from the tight interest rate stance since June 2004. They hope to gain a clearer idea of the gap between the current federal funds rate and the neutral rate.
The Neutral Interest Rate Framework
It is their view that the neutral rate is that which accords with economic and price stability. The idea of the neutral rate emanates from writings of the Swedish economist Knut Wicksell. According to Wicksell,
There is a certain rate of interest on loans which is neutral in respect to commodity prices, and tend neither to raise nor to lower them. This is necessarily the same as the rate of interest which would be determined by supply and demand if no use were made of money and all lending were effected in the form of real capital goods.[1]
In other words, the neutral rate of interest is defined as the rate at which the demand for physical loan capital coincides with the supply of savings expressed in physical magnitudes. (Note again that once the neutral rate is reached, that state of equilibrium is attained — implying that the economy is now well balanced and the price level is stable).
According to this view, the main source of economic instability is the variance between the money market interest rate and the neutral rate. If the market rate falls below the neutral rate, investment will exceed saving implying that aggregate demand will be greater than aggregate supply. Assuming that the excess demand is financed by the expansion in bank loans this leads to the creation of new money, which in turn pushes the general level of prices up.
Conversely, if the market rate increases above the neutral rate, savings will exceed investment, aggregate supply will exceed aggregate demand, bank loans and the stock of money will contract, and prices will fall. Hence whenever the market rate is in line with the neutral rate the economy is in a state of equilibrium and there are neither upward nor downward pressures on the price level.
Again, this theory posits that deviations in the money market interest rate from the neutral rate is what sets in motion changes in the money supply which in turn disturb the general price level. Consequently, it is the role of the central authority to bring money market interest rates in line with the level of the neutral rate of interest.
According to this view, to establish whether monetary policy is tight or loose it is not enough to pay attention to the level of money market interest rates; rather one needs to contrast money market interest rates with the neutral rate. Thus if the market interest rate is above the neutral rate then the policy stance is tight. Conversely, if the market rate is below the neutral rate then the policy stance is loose.
However, how is one to implement this framework? The main problem here is that the neutral interest rate can't be observed. How can one tell whether the market interest rate is above or below the neutral rate? Wicksell suggested that policy makers pay close attention to changes in the price level. Thus a rising price level would call for an upward adjustment in the money rate, while a falling price level would signal that the money interest rate must be lowered.
According to the Wicksellian framework, in order to maintain price stability and economic stability, once the gap between the money market interest rate and the neutral rate is closed the central bank must at all times ensure that a gap does not emerge. In the Wicksellian framework a monetary policy that maintains the equality between the two rates becomes a factor of stability. But is this possible? After all, maintaining this equality means that the central bank would have to manipulate the supply of money, which in turn will make things unstable.
In order to reach the neutral interest rate and hence price stability, the central bank must be forward-looking. The Fed must try to counter possible future movements in economic activity in order to reach the desired goal. Bernanke's present setting of interest rate is expected to counter various future factors that might prevent attainment of economic equilibrium.
There is always the possibility that Bernanke's assessment of the future course of the economy may turn out to be wrong. Even if the Bernanke's assessment of economic fundamentals proves to be accurate he could still be wrong on the monetary policy's time lag, which tends to shift.
For instance, our empirical analysis indicates that between 1963 to 1972 the average time lag between policy and effect stood at 10 months. Between 1973 to 1989 the lag was 12 months and from 1990 to present the lag is 15 months. Consequently, if Bernanke's assessment of the time lag turns out to be wrong, his interest rate setting may turn out to be not of an offsetting and stabilizing nature, but rather it may end in reinforcing economic swings — leading to more instability.
Consider the possibility that the monetary policy time lag has lengthened further and economic activity may still stay quite strong at least until the year end. In this case, by keeping the interest target unchanged at 5%, Bernanke runs the risk of strengthening the money supply rate of growth and thus setting the platform for higher inflationary expectations and higher price inflation in the future.
A stronger pace of economic activity whilst the federal funds rate target is relatively too low may give rise to a stronger demand for federal funds and this could force the Fed to lift the supply of money to defend the 5% federal funds rate target. Obviously, printing more money will only further destabilize the economy.
So far it seems that the federal funds rate target has been far too low relative to the pace of economic activity, which in turn forces the Fed to pump money at an increasing pace. After falling to 3.6% in November last year the yearly rate of growth of Fed Credit (the Federal Reserve balance sheet) climbed to 4.7% by the middle of May. Also, the growth momentum of money AMS has been in a visible increase since November last year. Year-on-year the rate of growth jumped from 1.2% to 3% in April.
Even if Bernanke and his colleagues are correct in their forecast and economic activity does slow down visibly in the months ahead there is no way of knowing whether the interest rate target is at the "right" level. There is the possibility that the federal funds rate target of 5% may turn out to be far too high. The Fed might keep the 5% federal funds rate target for a reasonable period of time before discovering that economic activity is falling rather fast. This in turn means that to defend the 5% federal funds rate target — as a result of a falling demand for federal funds due to weakening economic activity — the US central bank will be forced to withdraw money from the economy. By acting this way, the Fed runs the risk of draining liquidity, thus setting in motion an economic bust. What the Fed is trying to achieve belongs to the world of a true free market economy. In a free market economy without a central bank, there would be no such thing as monetary policy. In the absence of central bank monetary policies, which enrich some individuals at the expense of other individuals, the interest rates that emerge would be truly neutral.
Central banking can't work: $45 Also, in a free market no one would be required to establish whether the interest rate is above or below some kind of imaginary equilibrium. In a free market, with the absence of money creation, there is no need for a policy to restrain increases in the price level. The whole idea of the neutral interest rate is unrealistic insofar as we have a Fed that continuously tampers with interest rates and money supply. Given the impossible goal that the Fed tries to achieve, we do not expect Fed policy makers to become wise and all-knowing with regard to the correct interest rate.
Sooner rather than later, Bernanke's Fed policy will assume a reactive nature — the US central bank will respond to the data. The fact that the data tends to mirror the effect of past Fed's monetary policies means that the Fed is likely to respond to its own past actions.
The Fed tries to control the future but ends up only chasing its own tail, which leads to more confusion and uncertainty. All this could be further aggravated if Bernanke were to start setting targets for price inflation. As is always the case with centralized monetary planning, attempts to stabilize only bring about more destabilization.
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Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. He maintains weekly data on the AMS for subscribers through Man Financial, Australia. Send him mail and see his outstanding Mises.org Daily Articles Archive. Comment on the blog.
The fed is always hypersenstive to inflation. The problem with the fed is they are all bankers and they are always looking at rates from the perspective of banks. Sure they want to keep the economy somewhat healthy, but their first concern is always with the banks.
Bwhahahahahahahahaahaa.
Warm me before you say something like that.
I'm still laughing over the absurdity displayed by the Treasury Dept by reducing the 6.75% return on I bonds to 2%, in effect saying that inflation is only at 1%. Stupid, stupid, stupid.
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I got mine, you mean y'all didn't get yours?
Hypersensitive to inflation??? If inflation is defined, as it should be, by an increase in the money supply, not by an increase in prices, then the Fed is totally responsible for inflation. That has been the job of the Fed since it was created and the Fed is in-league with the politicians. The pols get to spend what they want and they don't have to raise taxes. However, inflation, created by the Fed is the most insidious of taxes!
I am abolutely amazed that ANYONE would have nostalgia for 1932, considering its 23.6% unemployment, failing businesses, foreclosures on family farms and homes and the government's need to use the Army to put-down street demonstrations.
But, hey...
If Herbert Hoover is your "hero", what's the harm?
Oh?
What's that?
You DO want today's prosperity, but you want that prosperity without the FED, which has made today's prosperity possible?
I do hope you see that your "position" on the FED is just not logical.
If money supply stays constant and you have more and more goods being produced, that would cause massive deflation. Money supply has to grow along with GDP. That is the biggest problem with backing currency with gold, it is difficult to increase the money supply.
Bingo!!!
The key problem with Ludwig von Mises is his assumption of a "static" economy.
Perhaps Austria fits that description. America certainly does not.
I wonder if we can persuade the people who "wish" that the FED would just go away to "wish" up an every-expanding supply of gold instead...
Your comment is even more nonsensical than the bulk of this article. Generally those who know least about the Fed and Central Banking squawk the loudest.
Here is a slice of reality for them: NO modern state will ever consider eliminating the Central Bank. Only in primitive and developing capitalist countries is there no Central Bank. And NO, Central Banking is not the result of a conspiracy among the super rich bankers designed to enslave the common man.
Inflation has never been defined as an increase in the money supply. It is and always will be a GENERAL price level increase. There is no inflation caused by money supply increases at or below the level of productivity.
But thanks for playing.
You are addressing a religious faith here don't expect to convince the faithful.
For you genius's here, that is if you've got the scratch, I suggest you see this video on the Fed's creation and the other links of info never taught by self interested public educrats.
http://mises.org:88/Rothbard-Fed
http://modernhistoryproject.org/mhp/ArticleDisplay.php?Article=McFadden1932
Secrets of the Federal Reserve
http://www.barefootsworld.net/fs_m_ch_14.html
It is not I who need an education on the creation of the Fed nor its function in a modern economy and I doubt seriously that the links provided are sufficiently grounded in the truth to provide help for those who badly need it.
Central banking is an indispensible part of a modern capitalist economy. This is recognized by all serious thinkers on economics no matter what the Whackaloons at the LVMI say about it.
Let me guess the Medical Establishment is hiding the cure for cancer too.
That you think I long for 1932 is sheer idiocy. Hoover was as big a dolt as FDR and the rest of the progressives, even though he pledged a non-interventionist policy, he did not follow his own beliefs, but those of others.
American's largest gap in factual history is the period between the CW and WWII. For the progressives rewrote it to suit themselves and hide their hijacking of the country via the Fed's ability to roll the presses, over-regulate commerce for the benefit of Big Biz, and "....spend, spend, spend", as an FDR advisor told Eleanor who was fretting how to pay for programs she supported.
Read/see those links I last posted.
I don't care what you say, so justshutupandtakeit!
The Fed can't touch you.
BUMP
>>>If money supply stays constant and you have more and more goods being produced, that would cause massive deflation. Money supply has to grow along with GDP. That is the biggest problem with backing currency with gold, it is difficult to increase the money supply.
Agreed. The Fed should be relegated to some backroom operation by 2 or 3 employees in the Treasury. Every year they check the economy's growth statistics and then gently let out enough M-2 goodness to keep prices stable (around 4 per cent -- the growth rate of the economy).
This keeps the policy neutral with regards to lenders and borrowers, which is a good thing.
You have been kind enough to provide me with some reading material. Please allow me to do the same:
"...But in order to understand the evolution of the Fed and the role it plays in today's economy, it is important to know why, and how, the Federal Reserve System was established. Essentially, the evolution of the Fed didn't begin on Dec. 23, 1913; rather, the Banking Panic of 1907, the most severe of four national banking panics that had occurred in the previous 34 years, was the primary inspiration for major banking reform. Abram P. Andrew, secretary of the National Monetary Commission—the committee assigned in 1908 to study the country's banking problems—collected nearly two hundred samples of various bank currencies created to stem the 1907 panic, and he provided a vivid description of the banks' quandary at that time:
[The banks] were so singularly unrelated and independent of each other that the majority of them had simultaneously engaged in a life and death contest with each other, forgetting for the time being the solidarity of their mutual interest and their common responsibility to the community at large. Two-thirds of the banks of the country entered upon an internecine struggle to obtain cash, had ceased to extend credit to their customers, had suspended cash payments and were hoarding such money as they had. What was the result? ... Thousands of men were thrown out of work, thousands of firms went into bankruptcy, the trade of the country came to a standstill, and all this happened simply because the credit system of the country had ceased to operate.
The National Monetary Commission's list of banking problems was dominated by two flaws: a banking system prone to panics and a currency that was not responsive to changes in demand. To combat those problems the Commission made an urgent plea for effective lending to banks (referred to as “rediscounting” in the Federal Reserve Act). Banks in the earlier part of the century needed the flexibility provided by rediscounting if they were to meet the demands of the economy and avoid banking panics. Other problems highlighted by the Commission were inadequate supervision of banks and an inefficient check collection system..." [1]
In summary, since "free competition" among the banks, as permitted by a laissez-faire US government, had brought the US economy into a ruinous depression every 10 years or so, it became obvious that the external costs of that competition had to be tamed. And that's the REAL reason we have a FED.
But, hey...
Conspiracy theories" are much more entertaining, aren't they?
I only have some coins and some GG, that are doing very well indeed, however the rest of my portfolio has tanked badly recently, especially today.
I foolishly hoped it would be different this time from '87, '94 & 2001.
As of today, I have never been more certain that the Fed needs to be abolished for it's ineptitude or outright criminality.
How much American wealth has again gone down the Fed rathole today alone?
That the Fed has soooo much control of the markets indicates it has NEVER met it's mandate of stability.
My gut tells me all the biggest banking/brokerage interests have been slowly unloading into yet another Fed created boom/bust cycle - exactly what their 1913 creation purported to prevent!
Here's some very damning info on the Fed - even if much of it is wrong (which I do not think it is) - it would still be damning.
Secrets of the Federal Reserve
by Eustace Mullins
http://www.barefootsworld.net/fs_m_ch_01.html
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