> "If 18 months ago, you'd have said the Federal Reserve Bank could raise interest rates by 500 basis points, and the consumer would chug on, relatively unfazed, I would have been extremely surprised," says Ellie Henderson, an economist at UK-based, global bank Investec. "I'd have said, 'that's just not how economics works'."
Economics is such a funny field to me. The systems involved are incredibly complex, yet economists habitually speak as though their models are anything more than that: models.
Somehow we got into a place where policy is made on the explicit assumption that the Federal Reserve Bank is in possession of a mystical lever, a single number that they can change to steer the behavior of more than 300 million people. As a layperson, it's incredibly obvious that interest rates are but a single variable in an enormously complex equation that we have no hope of recreating in a spreadsheet, but somehow that comes as a surprise to the professionals.
Arguably, the more people, the better you can model aggregates. Just as with the gas equation - it works because there are so many molecules that individual idiosyncrasies are smoothed out.
And, so, yes, there have been regularities observed (that make theoretical sense, also); and when those break down, that is worthy of note and investigation. You can't just point to "oh, it's people", rather you should try to figure out what's systematically different this time.
> in possession of a mystical lever, a single number that they can change to steer the behavior
Federal Reserve has more than one lever. They set bank reserve ratios. They engage in outright buying of underwater (mispriced) paper through quantitative easing. They created a new program this year to swap SVB's mispriced bond holdings at par.
It's time to reel in Federal Reserve and reel in government deficit spending.
They can also change initial margin requirements (Reg T), but this hasn't been done in decades. Neither have reserve requirements been changed since they were dropped to zero in the wake of the GFC.
They do have a few numbers though. The Federal Funds rate isn't actually directly set by them, but rather, targeted, using other policy to "enforce" that target (in the form of open market operations -- buying and selling securities)
For what it's worth, it's amusing that they talk about the FF rate at all, given how vacant the market itself has been since the GFC (down to about $100B/night), as few care to engage in unsecured lending in the first place now that we all are painfully aware of counter-party risk. They do, however, directly set the reverse repo rate, the discount window rate (aka Primary Credit), and the prime rate (though, how much prime matters these days is a matter for debate).
Thanks for the reminder! I recall Fed was involved with something in reverse repo 6 months before virus blew up.
Federal Reserve has so many levers it becomes questionable that anyone understands medium to long term impacts. And FDIC works closely with Fed on bank bailouts like SVB.
>Economics is such a funny field to me. The systems involved are incredibly complex, yet economists habitually speak as though their models are anything more than that: models.
It’s funny that you bring this up, because this idea that the the power brokers forgot that their models were simplistic models of human behavior instead now thought of them as full, bidirectional descriptions of behavior is the thesis of many Adam Curtis documentaries. I’m thinking about the The Trap in particular.
>interest rates are but a single variable in an enormously complex equation that we have no hope of recreating
Or rather it's not even an equation. My decision whether to put off buying an iPhone if interest rates doesn't map to one really. Which doesn't stop people trying to estimate such probabilities with equations but it's a mistake to not recognise they are crude estimates of human behaviour.
I studied economics and totally agree with your mom. Because a very important aspect in economics is trust, which cannot be modeled and can change overnight.
“If you want to slow down the economy by 15% then raise interest rates by n basis points, have these 4 people from your senior admin do a press tour, leak the following information ‘accidentally’ on YouTube, and wait 8 to 10 weeks for results”.
Economics is such a funny field to me. The systems involved are incredibly complex, yet economists habitually speak as though their models are anything more than that: models.
Somehow we got into a place where policy is made on the explicit assumption that the Federal Reserve Bank is in possession of a mystical lever, a single number that they can change to steer the behavior of more than 300 million people. As a layperson, it's incredibly obvious that interest rates are but a single variable in an enormously complex equation that we have no hope of recreating in a spreadsheet, but somehow that comes as a surprise to the professionals.