The Threat of Fed Rate Hikes and the Constant Hum of Distortion

Let's not get too worked up over this whole Bernanke confirmation deal, there's still the issue of the Fed pulling out to attend to. Anything else is merely a distraction.


The Federal Reserve may now start pointing to the interest rate paid on reserves as its primary monetary-policy tool, economists at Bank of America Merrill Lynch said.

What is generally referred to as the Fed’s benchmark rate is the target overnight interest rate between banks. That fluctuates on any given day anyways, depending on short-term money market trading and activities by the Fed to push the rate up or down. It’s hovered around 0.12% for the past month at least.

The possibility of paying interest on reserves has been suggested by some Fed officials as a way of draining liquidity from the financial system to help assuage fears of runaway inflation when, or if, the economy ever gets back up to speed again.

Bank of America said the Fed will also shift from aiming for a target fed funds rate, to announcing a range, like it is now, at zero to 0.25%. The interest rate paid on reserves would stay at the upper end of the fed funds rate, Bank of America’s Ethan Harris wrote in a note Tuesday.

Mish had a great piece on December 14th on Fed distortions, specifically the fact that its very existence throws off markets. No kidding!

The Observer Affects The Observed

The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.

To measure the position and velocity of any particle, you would first shine a light on it, then detect the reflection. On a macroscopic scale, the effect of photons on an object is insignificant. Unfortunately, on subatomic scales, the photons that hit the subatomic particle will cause it to move significantly, so although the position has been measured accurately, the velocity of the particle will have been altered. By learning the position, you have rendered any information you previously had on the velocity useless. In other words, the observer affects the observed.

The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.

Yes but isn't the Fed trying to throw the signal to game the system back?

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.


W.C. Varones said...

Rate hikes my ass.

The Fed has created an economy dependent on free money. They can't raise rates meaningfully or they'll crash the whole thing.

Milton Friedman talked about Fed induced instability about 40 years ago. He said the way the Fed affects markets is by deceiving them as to its true intentions, thus creating more than less instability. Robert Higgs has written about this too.