Richard
Elite Member
- Joined
- Apr 6, 2000
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- Location
- Knoxville, TN
- Tractor
- International 1066 Full sized JCB Loader/Backhoe and a John Deere 430 to mow with
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??
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??
