Why has the FED resisted the private market's rate increase by keeping the interbank funds rate artificially low? They did this to create extra money so that prosperity would be assured. They are fighting the market. They are saying the market is wrong. Meanwhile the propensity to inflate continues to rise. So they have to take some money back by letting fed funds rise to balance the demand for loanable reserve funds with the instantaneous supply.
The problem is that they have no idea where equilibrium lies. It is pretense to knowledge to think that that is knowable. It isn't. That's why we have free markets, but we don't have a free market in money. We have a fixed market. Fixed by the wisdom of the FED.
First they will let fed funds rise a little to see what happens. What will happen is not much. Then the economic machinery will continue to act as it has and also will reflect the new FED rate increase rational expectations factor. This means buying before rates rise more. It creates an artificial demand not only for loanable funds to create more goods, but also demand for more goods. That demand increases faster than the ability of the economy to make them. Thus prices rise. So the FED has to raise rates more, but not too much since they are trying to preserve prosperity through their infinite wisdom.
When you fix prices, you are presuming infinite wisdom. The market doesn't have infinite wisdom. It has to adjust prices daily to reflect changing information and circumstances. But the FED knows what they need to know through experts and computers. Thus they fix the price of money. They supply reserves daily to keep rates from rising. It is referred to as an "add need".
So where does all this end? As long as FED tries to maintain prosperity the eventual break from prosperity will be ever greater. They would never have this problem in the first place if they simply let the market decide the cost of funds. They always have procrastinated. That means suddenly they'll raise rates 1% and they won't announce it. That will slam the markets and it will have to be done because inflation will be rapidly heating. You can't go about tightening half-assed once you commandeer the market and make the infinite knowledge assumption. In 1979 the FED had to stop open market operations and let the free market raise rates through the roof. The longer they resist, the greater will be the increase and the effect will smash the stock market. If the stock market crashes, the FED will have to attempt to flood the economy with more money which is like throwing gasoline on a fire.
You might think they are too smart to do that. They would just let the economy recess. Infinite wisdom is also equivalent to infinite stupidity. Where there is knowledge, there is ignorance. I heard Milton Friedman say the FED was doing a good job. You can't appreciate what this means, but it is the most bearish statement I've heard in 20 years. I am a student of Miltie and I can't believe I heard him say that. I can only conclude that the FED's '88 -'93 experiment with money targeting was deemed a failure by Miltie of his own views and so he has joined up with the demand managementists. Impossible. I can't explain it, but Miltie is saying it is possible to manage the cost of money by saying the FED is doing a good job. They can't be doing a good job because the job, much more a good job, can't be done. Everything they're doing is robbing Peter to pay Paul, and you will be paying especially if you are fully exposed to the charade called the stock market. |
