Tuesday, November 24, 2009

The Federal Reserve and Over-controlling

The following is an article that was meant to be published in December 2007, but I never clicked "publish."

A friend called me and asked "What's the biggest cut the fed has ever done?" So, I looked up the entire history of Fed Funds rate changes.

  • The last time the Fed moved more than 50bp in either direction was 1994, when they raised 75bp to 5.5%.
  • There hasn't been a 100bp cut since August 1982.
  • In 1980, they raised, lowered, raised, and lowered rates.
  • The fed changed rates 23 times in 1978.
Changing rates 23 times in a year is an example of over-controlling.

Over-control occurs when the control inputs feedback through a process, which can increase the variance of the process output rather than dampen the variance.

An analogy is learning to fly a plane. Here's a description from a student pilot website:
"The natural, normal reaction of a student pilot in turbulence is to grip the yoke more firmly. This is what you do going over chuck-holes in an automobile. In an airplane a firm grip gives you a two-for-one bump. A light touch will reduce the extent of light to moderate turbulence significantly."
Another pilot instructor says that he "once facetiously suggested that a student sandpaper his finger tips to force him to lighten up on the controls."

Why should we have to put up with an amateur pilot on the controls of the economy?

An interest rate is a type of price. A free market is one in which prices are determined by the mutual, non-coerced consent of sellers and buyers.

In the Soviet Union, "planning ministries (also known as the "fund holders" or fondoderzhateli) defined the mix of economic inputs (e.g., labor and raw materials), a schedule for completion, all wholesale prices and almost all retail prices."

After many failed experiments, we now know that prices set by the free market are the best way of allocating scarce resources.

End the Fed.


eh said...

GE Capital Losses May See Dramatic Fall: JP Morgan

eh said...

An analogy is learning to fly a plane.

A helicopter would have been a better analogy.

eh said...

More noise about GE -- will no longer trade like/with a/the financials, a spike in 20+ call buying for 2011.

FWIW, i.e. consider the source.

CP said...

Ha. Seriously though - shouldn't Ben lighten up on the controls?

That call buying would be consistent with the high levels of call buying in the broader market.

Anonymous said...
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eh said...

Well, yes, I agree with the gist of your post. And behind the facade Bernanke seems like the nervous, panicky type (you can see the fear and worry in his eyes), more likely than not to cut first and ask questions later. But then that's what can and will happen with fiat money -- you can have more or less as much of it as you want. I guess not so much that's it too heavy to drop from a helicopter, though.

CP said...

I love what Ron Paul says about Ben:

I want no more bowing and scraping to the Fed chairman when he goes to Capitol Hill to peddle his nonsense. He is just a bureaucrat, albeit a disastrous one.