Those are the goals of the Federal Reserve. They are contradictory, yes, but nobody says anything. In my opinion, the part about maximum employment should be the redoubt of the Treasury or elected government while the last two should be the goals of the Feds. That way, we can have the two groups promoting policies that may balance each other out. But for the Feds to worry about unemployment would make it a victim of short-term thinking, when it should really be thinking about prices. The European Central Bank is far more concerned about inflation than employment and it has done a much better job than the Feds in that department. But if we were to concentrate all the Feds resources on battling inflation and take away many of its current powers, leaving regulation to another government body, we could have multi-headed system that would complement and balance each other out. Since there would be no need for discretionary thinking, all this could be done via an algorithm using stochastic and regression processes to determine what the interest rate should be.
Is it time to replace the Federal Reserve with a computer?
- Thread starter Dari
- Start date
Those are the goals of the Federal Reserve. They are contradictory, yes, but nobody says anything. In my opinion, the part about maximum employment should be the redoubt of the Treasury or elected government while the last two should be the goals of the Feds. That way, we can have the two groups promoting policies that may balance each other out. But for the Feds to worry about unemployment would make it a victim of short-term thinking, when it should really be thinking about prices. The European Central Bank is far more concerned about inflation than employment and it has done a much better job than the Feds in that department. But if we were to concentrate all the Feds resources on battling inflation and take away many of its current powers, leaving regulation to another government body, we could have multi-headed system that would complement and balance each other out. Since there would be no need for discretionary thinking, all this could be done via an algorithm using stochastic and regression processes to determine what the interest rate should be.
NikolaeVarius
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The Terminator: The Skynet Funding Bill is passed. The system goes on-line August 4th, 1997. Human decisions are removed from strategic defense. Skynet begins to learn at a geometric rate. It becomes self-aware at 2:14 a.m. Eastern time, August 29th. In a panic, they try to pull the plug.
Sarah Connor: Skynet fights back.
The Terminator: Yes. It launches its missiles against the targets in Russia.
John Connor: Why attack Russia? Aren't they our friends now?
The Terminator: Because Skynet knows the Russian counter-attack will eliminate its enemies over here.
Inflation in Europe is about on par with the US, but unemployment is much higher. So your first premise is wrong.
Who programs the computer with what variables? I think you're missing the very first premise of building models, GIGO.
Unemployment is higher because of rigid European laws, not because of monetary policy.
As for the variables, you throw in as many variables as possible and do stepwise regression on the data with an alpha of 1% in and 5% out and see which variables are the most pertinent. This is all basic statistics that economists ignore because they like to focus on simple equations. Once you figure out the correlation between the variables you can setup a nice equation and do a simulation to see what happens. If the results are competent, then you have yourself a winner.
This is interest rates we're talking about, not national defense. People can choose to ignore it, pass a new law, or simply unplug the computer.
Do you even know the complexity of measuring and regressing a whole fricking economy, but then not having all variables?
I love when armchair generals attempt to understand economics and finance from outside the universe, claiming all the while it's as simple as a regression.
There isn't one model pre 2007 that would have thought that subprime securitization would cause the problems they have. The Fed, nor a model, would have been able to adjust for the global flood of capital into the US debt markets, more than $20TR in total, which drove down long-term interest rates far outside the control of the Fed. That variable alone accounted for the majority of the issues we now face, a variable that has never been accounted for before.
It only takes one independent variable outside of the current IV's in a model to blow the whole model. Look at the rating agencies. They have collected data on over 100Tr of securitization debt over the last 40 years, yet blew it with CDO's because their models didn't include the whole gamut of exotic mortgages.
What's even funnier is that people try to extrapolate this situation to other forms of securitization debt, such as auto and credit cards. Yet they fail to realize that those models work quite well, even under severe stressed situations.
The entire economy cannot be encapsulated in a model because you are attempting to gauge human behavior, which is far outside quantifiable terms. Consumer, corporate, worldwide investor sentiment ebbs and flows on a moments notice and are impossible to predict.
If models worked at encapsulating all human behavior and economic variables, then a hedge fund would have created it and would be rolling in so much money as to make all other "rich" people seem like paupers. As somebody who has worked with some of the most profitable hedge funds, I know that they can't even get close to this.
The last time people thought a model could predict the correct market movements it required one of the biggest financial bailouts in history, LTCM, which was created by a few of the smartest people that finance has ever known. One of the other largest problems models caused, from program trades, was 1987.
The first thing you learn about models when you go into finance is that they can and do fail quite often. Human intuition is far more accurate at gaugeing changing human behavior.
Models have one fatal flaw, they run on data that's already stale from the market's perspective, because they cannot predict the next second's human's behavior.
I can point out dozens of econometric models that have failed miserably in the last year.
I'm not even sure why you brought in the sub-prime mess into this topic and yet forget to mention the Feds' actions, which is precisely why I made this proposal. Look at the market before and after the subprime implosion. Before, the Feds was slow to cut rates. After, it's cutting it like there's no tomorrow. This is part of the problem and you fail to mention it. Easy money is part of the problem and the Fed is guilty of that. Take away the human factor (political pressure, worries about employment, and errors) and you'll have a more stable inflation targeting regime.
Oh, and try not to insult people when you don't even know who they are.
You simply don't get it. The Fed trying to cut rates in the face of $20TR flooding into the market is akin to pissing into the wind of a Cat5 hurricane. The Fed had absolutely no control over that money, it was risk-spreads that cut funding costs, not benchmark rates for short-term securities between banks, which is what the Fed sets.
Look at right now, if the Fed had control over long-term rates, then you'd see mortgage rates collapse. HOwever, they have barely moved. Why? Because risk-premium have skyrocketed. I know many funding deals which I have looked at which priced from 55bps last year to over 250bps this year. That's a funding increase of 190bps, which completely cancels the Fed's actions.
I know another consumer loan deal that funded at 50bps all-in last year and is now going to fund at 400bps this year, net-net, over swaps, that's a 200bps funding cost increase. That's passed onto consumers.
The Fed has no control over that, it's the global financial markets which provide liquidity that sets the market. Those markets cannot be predicted by simple regression. It'd require tens of thousands of variables, all adjusting within a moments notice, all plugged into the entire market's psychology.
There is a reason why the markets are called "random walks", it's because you can't predict the future. If you could, then systematic risk would be 0 and the returns on the market would collapse down to risk-free rates.
Take away the "human factor"? ROFL, the human factor is what MAKES this market variable, which is the exactly what you fail to understand.
Go read up on Behavioral Finance books, I have read dozens. I don't give a crap who you think you are, your ideas are parochial at best and anybody in a remedial financial analysis and modeling class would know you're barking up the wrong tree.
And you keep missing my point. If the Fed had been less politicised and less worried about employment, it would've put the squeeze when the economy was at it's hottest. Of course, basic economics also says that governments should raise taxes at such times as well to use them when the economy is in a recession, but people also ignore that. The whole point of a truly independent Federal Reserve would be to nip these problems in the bud before they are allowed to grow. If we let the Feds worry only about inflation and stable prices, the politicians worry about job creation, the treasury worry about debt, and various other agencies worry about regulation, then I'd believe we'd have a more sedate boom-bust cycle. It may not be interesting, but it shouldn't be.
An ounce of prevention is worth a pound of cure.
I see your point, but it's flat out wrong. The Fed could have raised rates to 6% and it wouldn't have mattered. Long-term rates set housing funding costs, not short-term rates. Long-term rates are set by the market, not by the Fed. If the market is flooded with capital it will drive down risk-spreads, as it did.
Not to mention that the biggest problem currently is not long-term rates themselves, but creative financing, which the Fed has no control over.
You blame the Fed and imagine a computer would solve the problem. I blame the market and say that a computer is as fallible, if not more, than humans.
Humans program computers, but adjust on a moments notice. Computers cannot adjust and still rely on humans to program. Thus you add in two levels of fallibility, not just one.
Boom/bust cycles have existed throughout humanity and cannot be controlled by funding rates. I would think that history has proven this to most people. Look at the Tulip case.
While you are at it, let's replace the whole freaking government with computers. Everything is simply input variables and some output. No need to fight over budget, no more bipartisan bickering. Let's rule the world with multivariate regression analysis. It's the answer to every problem we have in life.
Why don't we just replace all human decisions with computers, since Dari thinks that human decisions can be determined by regressions. Easy way of being lazy and taking the predictability from the world, eh?
I don't know, you don't know, and the Fed does not know what to do. This is a key reason why the Fed should be abolished......
Replaced by what? Politicians who *REALLY* don't know? Seems to me that a relatively independent Fed has done more to prevent bigger problems than the govt.
Long-term rates may set housing costs but people determine whether or not to make housing purchases on short-term rates, Bernanke and Gertler (1995), so the Fed does have a huge impact on such investments.
If the market is flooded with capital, a truly fluid and independent Federal Reserve can have the Treasury mop them up while imposing a special tax on such inflows. By doing this, they will avoid raising rates which would attract more capital.
Creative financing only works when capital is cheap. By imposing a rigid system monetary policy, we can get rid of our obsession with debt.
The market is not at fault at all if they followed the rules laid before them. The fact is they exploited the rules and the Federal Reserve just wagged its fingers at them, while letting interest rates fall or rise slooowly.
Computers can impose a rigid order that humans are too afraid to do because of political pressure and to keep their jobs.
Boom-bust cycles can be less volatile if we want them to be, but only if we have the will to want a more sedate cycle.
How about a free market.....
An example of this is the 1% Fed Funds Rate in 2003-2004. I doubt the market on its own would have reduced interest rates to 1% or held them there for long if it did.
The Fed held rates rates too low too long. This created the biggest housing bubble in history. The Greenspan Fed at a very bad time, compounded the problem by endorsing derivatives and ARMs.
An example of this is the 1% Fed Funds Rate in 2003-2004. I doubt the market on its own would have reduced interest rates to 1% or held them there for long if it did.
The Fed held rates rates too low too long. This created the biggest housing bubble in history. The Greenspan Fed at a very bad time, compounded the problem by endorsing derivatives and ARMs.
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