Any economists here?

[Richard]

Yesterday, I had someone in my office that is a retired engineer/mathematician. He spouted off a concept that to my pea-brain sounded interesting. Not being bright enough to see if there is an inherent flaw in the concept, I thought I’d post it here for kicks and conversation. I’m sure I will butcher the concept some, so be patient and liberal with your understanding.

Scenario: Fed (Mr. Greenspan) at times desires to ramp the economy up or down. To achieve this goal, they raise interest rates to slow and lower rates to speed the economy. My visitor’s suggestion is that this simplistic move by the fed is “backwards” primarily because of the “herd” mentality of the population (when considered as a whole). Here is a rudimentary view of his ideas.

For illustration purposes. Lets say current interest rates are 6%


Situation 1: Fed wants to SPEED up the economy. They desire interest rates to be at 4% so they let the inference out that rates are going to go down (you know, ¼ point every 4 months or so). What happens? Economy SLOWS.

Problem: You, preparing to purchase your next house, car, or tractor, realize that if you buy NOW, you pay 6%. If you wait a while, maybe 5 ¾, wait a while longer, maybe 5 ½, longer, 5 ¼ and you get the idea, so purchases slow down waiting for the lowest rate one is comfortable with. Fed wanted to SPEED things up, and in fact, they have SLOWED down with the lowering of rates because of people waiting to make their big purchase to get lower rate.

His solution: Fed IMMEDEATELY drops rates from 6% to say 2% and announces that over the next say, 4 months, rates are going to go back UP to 5 ¼%. What happens now??? Well, with rates at 2% and you knowing they are going back UP, you don’t wait to make your purchase. In fact, you go out and make it sooner rather than later to save on rates. By making your decision NOW, and purchasing, the economy gets pushed forward just as fed wanted.


Situation 2: Fed wants to SLOW the economy. They desire rates to be 8% so they let the inference out that rates are going to go up. What happens? Economy SPEEDS up.

Problem: You, preparing to make major purchase, race out to finish transaction so you can lock in lower rates. Fed wanted to slow things, yet in fact, sped them up because of the expectation of rates going higher.

His solution: Fed IMMEDEATELY raises rages from 6% to say 10% and announces that over the next 4 months, rates will go back DOWN to 7%. Now what happens? You immediately put off your major purchase knowing that if you wait 3 to 4 months you can purchase at lower rate. Effect is economy is immediately cooled with fuel coming into system over time as rates come down.

His contention which I find some merit in is that with the Fed dinkering around with things like they do, can cause the swings to be greater doing it the way they currently do than if they did things his new way. If Fed did things as above, the economic swings we get could be much “smoother” in their vacillation from their peaks to valleys.

Don’t flame me too much for using some silly rates like 2%. I’m doing that just to try to paint the picture.

Comments??

[Thomas]

Richard,
I guess you could call it a quick fix at times by the Feds.

My view...its mostly the blue collar homes that pay the USA bills etc..

I'm not saying the goverment not trying,but some of these give away programs have got to be enforced better or stop.

There are so many issues which reflect on the USA..third worlds needs..USA becoming a police department for the world..etc...maybe its about time the USA check to make sure just how strong the foundation is here at home...heck we voted these poeple in...and like the old saying goes..Sh.t or get of the pot..hey we have to balance our check books etc...
Okay Okay you got me going Richard, [img]/w3tcompact/icons/wink.gif[/img]so I'm going to scoot out of here.

Have a pleasant day and stay [img]/w3tcompact/icons/cool.gif[/img]

Thomas..NH [img]/w3tcompact/icons/wink.gif[/img]

[Boots]

Richard,

I'm no economist, but I put quite a bit a thought into the subject following the post, and came up with one conclusion .... thinking about this too much will give you a headache. I find it works better for me when I blindly accept that our leaders know what they're doing. This way, I have more time to fantasize about buying my first tractor.

Merry Christmas!
Boots.

[Bird]

I believe it was Harry Truman who said, "If you took all the economists in the world and laid 'em end to end, they'd point in all directions."[img]/w3tcompact/icons/laugh.gif[/img]

Bird

[DONOTDELETE]

I'm not an economist but a thought about the fed and interest rates.
A quote from Abraham Maslow comes to mind. "If the only tool you have is a hammer, you tend to see every problem as a nail."
The only tool the Fed is using is interest rates, sometimes it may be the right tool sometimes we might be better served if they could use something else.
Your friends observations may me true but it's just another way of using the same hammer.

[TWINKLE_TOES]

Just a thought(stolen) about the economy

"It's tough to make predictions, especially about the future" <font color=red>Yogi Berra</font color=red>[img]/w3tcompact/icons/smile.gif[/img]

[ERNIEB]

I think his contention is a correct one, but I think the Feds have their reasons for doing it the way they do. I'm sure I wouldn't agree with their reasons. Naw, I better not climb up on a soap box for this one, so nuff said.[img]/w3tcompact/icons/wink.gif[/img]

ErnieB
"We must defend our rights, ourselves, and our country by force of arms."
Stephen F. Austin

[TomG]

It doesn't work--at least according to some economists. Some research was published a few years ago, which found that it takes over two years for the overall economy to react to a change in Fed Rates on average. However, the economy is complex. Major accidents and unforeseen circumstances occur more frequently than two years. The conclusion was that at any point in time, it is not possible to determine which direction rates should be moved, let-alone the how much to move them, to achieve a desired economic effect.

The idea is that monetary policy is a little like practicing safe driving techniques on the highway at night. The practice may make a person feel comfortable, but in practice, drivers are out of control a lot of the time. Under many conditions, by the time a need to stop is perceived, it's already too late. The main reason why safe driving campaigns persist is that they do prevent some of the minor problems, and they make people feel good. The techniques don't do much about the big problems, which of course, don't happen very often. that's why we keep calling them accidents I guess.

[Wingnut]

Economist? no! Opinionated? You bet!
Alan Greenspan is an old guy who thinks of the economy as a testbed for his theroies. Note the key word -- theories.
And, although people who've made major bucks off the stock market think he's a genius, he is still tinkering and trying to make people think he's clairvoyant.
Obviously he isn't.
My limited knowledge comes from managing 3/4 of a billion dollars in spare parts inventory for a major manufacturer. I've been involved in this stuff for most of 30 years and I've seen the economy ebb and flow in that time ... both here and in Canada ... and marvelled at how governments get taken in by these con men.
With all their screwing around, have they ever been proven to prevent a recession? End a recession faster? Nope.
My real problem about the "Fed" is what it really is. Have any of you guys and gals ever read up on it? It's got nothing to do with the government at all ... it's a collection of bankers. And what do banks do? Hmm. let me see ... lend money? Talk about allowing the wolves to rule the chicken coop.
I've marvelled in the past year at the way the stock market reacts to Greenspand twitchings, winks and offhand comments. Since so much money is out there now in mutual funds ... managed by just a few stampeding sheep ... it's no doggone wonder that THREE TRILLION bucks has evaporated this year.
OK, off my soapbox ... aren't you sorry you started this thread?
(and yes, I think you friend understands ecomomics pretty well .. and likely believes we need to go back on a gold standard, too)

pete the pontificator

too bad that common sense ain't