6 ms·

Does anyone know why the FED has to keep manipulating the supply of money? Let's say we have a very responsible government which taxes well, reinvests well in

by NTDF9 8y ago

Does anyone know why the FED has to keep manipulating the supply of money? Let's say we have a very responsible government which taxes well, reinvests well in productive work, private markets that operate smoothly, why does the FED have to step in periodically to raise/lower interest rates (outside of very bad circumstances). Another way of asking this question is, "What is a neutral rate?" or "What is an economy in equilibrium?"

DSingularity 8y ago
Because economies tend to get carried away. The fed comes in to pump the breaks by lowering/raising interest rates.
- NTDF9 8y ago
  Why can't the government do that with structural changes? What is the role of the money supplier?
  - klodolph 8y ago
    Since we have fiat currency we must therefore have monetary policy. We can either adjust our monetary policy in response to changes in the economy or we can nail it to a peg and hope that it works.
srgseg 8y ago
It's important for the US dollar to maintain reasonably constant and predictable purchasing power from year to year. This is part of their dual mandate. Their target is just under 2% inflation per year, as measured by the Core-PCE index. If the dollar didn't have reasonably constant and predictable purchasing power, people would be afraid either to issue or to take out loans denominated in USD. Manipulating the supply of the dollar via interest rate adjustments, along with open market operations, is how the Fed attempts to control inflation.
Nasrudith 8y ago
In terms of Fed policy it means they are neither focusing on restraining inflation (and thus economic growth) with high rates nor promoting growth (and thus inflation) with low rates. Equilibrium means that they don't need to intervene for either problem right now - and both have proven to be problems to be avoided.
- mamon 8y ago
  I'm not so naive to think that FED's goal is restraining inflation. Also, I don't know why people think of inflation as if it was some force of nature - it isn't. Inflation is created artificially by central banks, as a form of hidden tax on all of the citizen's wealth. Increasing inflation is the easiest way to help repaying government debts, because government is first to spend the money that FED creates out of thin air, thus screwing everyone else over.
twblalock 8y ago
All you need to do is look back a little over 100 years to a time before we had the Federal Reserve. It didn't look good. There was no equilibrium, but rather a boom and bust cycle, banks going under and people losing their life savings, and so on. One of the Fed's purposes is to moderate that cycle. And clearly it does not always succeed, but there is no reason to believe that the economy would reach some kind of equilibrium or neutral rate without it, because we know that didn't happen before the Fed existed.
- mamon 8y ago
  The boom and bust cycle was actually a good thing: it gave badly managed companies an "opportunity" to go bankrupt before they grew "to big to fail". Now that FED tries to regulate market cycles it actually makes things worse. It's not a coincidence that The Great Depression happend mere 16 years after creation of FED. And while some people did loose their savings during "bust", they could quite easily make up for it during the "boom" that followed. I don't expect economy to reach equilibrium, some mythical state of neverending growth. I want economy to stay dynamic, with boom periods interlaved with occasional, small crises.
- NTDF9 8y ago
  The best explanation. Thank you. I wonder if there's a better way to do this though. Maybe letting lenders fail, arresting bankers for not pricing risks in loans and setting an example is a better way to set up the money supply? The busts are only painful if they affect non-speculators. Speculators (lenders and borrowers) should handle their own risk? I'm sure it's not easy but the current system really really favors the rich with resources at the expense of retail retirement stock holders.
  - twblalock 8y ago
    > Maybe letting lenders fail, arresting bankers for not pricing risks in loans and setting an example is a better way to set up the money supply? I'm not in favor of arresting people who did not break any laws, and it's not illegal to misjudge risk when making loans.
013a 8y ago
Simply, an "economy in equilibrium" is one in which there is no concept of Debt. Once you introduce Debt you get cycles. If I make $50k and can borrow $10k, I can spend $60k despite $10k of that $60k being "created from thin air". This creates an exponential growth curve whereby if I'm spending $60k, the sum of all the people who receive the $60k I spent could borrow $12k, allowing them to spend $72k. And so on. When spending (and thus growth) is high, the central bank increases interest rates to slow it down, because too much spending leads to rising price of goods, which leads to inflation, which is not something anyone ever wants too much of. When spending is low, the central bank drops interest rates to ramp it back up. Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total. I can repay that $100k, even with interest, and have a bunch of money left over. My productivity (ability to generate income) increased, and it was only possible because of Debt. So we can get rid of debt, but we know that over the long term the economy will grow slower without it than with it. Its the job of the fed to try and keep as much equilibrium as possible, which is insanely difficult given the complexity of a 7 billion actor economy, many of whom do not treat debt with the respect it needs.
- NTDF9 8y ago
  Very good explanation. Thank you! > Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total This is the part where I fumble. In a society with 2 citizens and one bank, if citizen 1 borrows $100k, the maximum profit they can make = money borrowed by citizen 2. Three cases in the above example with 10% interest: 1. Citizen 2 doesn't borrow but instead just lives by hunting deer. Citizen 1 and the bank will go bust 2.Citizen 2 borrows 200k and spends 100k on something citizen 1 provides. Citizen 1 makes 100k profit and repays the loan with interest, say total 110k. Now citizen 2 is still on the hook for 220k. How will Citizen 2 get 220k if he has only 100k left and the other citizen has only 90k left? The only way I see it is they produce another kid who takes another loan. 3. Citizen 1 takes 100k loan, Citizen 2 takes 5k loan. Citizen 2 pays 5k to Citizen 1. Citizen 1 did not make enough to repay the 10% interest. So bank sucks it up and gets back 105k. Citizen 2 absolutely doesn't have any money to repay that 5k loan they took. So both Citizen 1 and 2 are busted. What now? They have to take more loans infinitely? (Short of producing other citizens who take loans) I would really appreciate your views.

by NTDF9 8y ago

DSingularity 8y ago

Because economies tend to get carried away. The fed comes in to pump the breaks by lowering/raising interest rates.

NTDF9 8y ago
Why can't the government do that with structural changes? What is the role of the money supplier?
- klodolph 8y ago
  Since we have fiat currency we must therefore have monetary policy. We can either adjust our monetary policy in response to changes in the economy or we can nail it to a peg and hope that it works.

srgseg 8y ago

It's important for the US dollar to maintain reasonably constant and predictable purchasing power from year to year. This is part of their dual mandate. Their target is just under 2% inflation per year, as measured by the Core-PCE index. If the dollar didn't have reasonably constant and predictable purchasing power, people would be afraid either to issue or to take out loans denominated in USD. Manipulating the supply of the dollar via interest rate adjustments, along with open market operations, is how the Fed attempts to control inflation.

Nasrudith 8y ago

In terms of Fed policy it means they are neither focusing on restraining inflation (and thus economic growth) with high rates nor promoting growth (and thus inflation) with low rates. Equilibrium means that they don't need to intervene for either problem right now - and both have proven to be problems to be avoided.

mamon 8y ago
I'm not so naive to think that FED's goal is restraining inflation. Also, I don't know why people think of inflation as if it was some force of nature - it isn't. Inflation is created artificially by central banks, as a form of hidden tax on all of the citizen's wealth. Increasing inflation is the easiest way to help repaying government debts, because government is first to spend the money that FED creates out of thin air, thus screwing everyone else over.

twblalock 8y ago

All you need to do is look back a little over 100 years to a time before we had the Federal Reserve. It didn't look good. There was no equilibrium, but rather a boom and bust cycle, banks going under and people losing their life savings, and so on. One of the Fed's purposes is to moderate that cycle. And clearly it does not always succeed, but there is no reason to believe that the economy would reach some kind of equilibrium or neutral rate without it, because we know that didn't happen before the Fed existed.

mamon 8y ago
The boom and bust cycle was actually a good thing: it gave badly managed companies an "opportunity" to go bankrupt before they grew "to big to fail". Now that FED tries to regulate market cycles it actually makes things worse. It's not a coincidence that The Great Depression happend mere 16 years after creation of FED. And while some people did loose their savings during "bust", they could quite easily make up for it during the "boom" that followed. I don't expect economy to reach equilibrium, some mythical state of neverending growth. I want economy to stay dynamic, with boom periods interlaved with occasional, small crises.
NTDF9 8y ago
The best explanation. Thank you. I wonder if there's a better way to do this though. Maybe letting lenders fail, arresting bankers for not pricing risks in loans and setting an example is a better way to set up the money supply? The busts are only painful if they affect non-speculators. Speculators (lenders and borrowers) should handle their own risk? I'm sure it's not easy but the current system really really favors the rich with resources at the expense of retail retirement stock holders.
- twblalock 8y ago
  > Maybe letting lenders fail, arresting bankers for not pricing risks in loans and setting an example is a better way to set up the money supply? I'm not in favor of arresting people who did not break any laws, and it's not illegal to misjudge risk when making loans.

013a 8y ago

Simply, an "economy in equilibrium" is one in which there is no concept of Debt. Once you introduce Debt you get cycles. If I make $50k and can borrow $10k, I can spend $60k despite $10k of that $60k being "created from thin air". This creates an exponential growth curve whereby if I'm spending $60k, the sum of all the people who receive the $60k I spent could borrow $12k, allowing them to spend $72k. And so on. When spending (and thus growth) is high, the central bank increases interest rates to slow it down, because too much spending leads to rising price of goods, which leads to inflation, which is not something anyone ever wants too much of. When spending is low, the central bank drops interest rates to ramp it back up. Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total. I can repay that $100k, even with interest, and have a bunch of money left over. My productivity (ability to generate income) increased, and it was only possible because of Debt. So we can get rid of debt, but we know that over the long term the economy will grow slower without it than with it. Its the job of the fed to try and keep as much equilibrium as possible, which is insanely difficult given the complexity of a 7 billion actor economy, many of whom do not treat debt with the respect it needs.

NTDF9 8y ago
Very good explanation. Thank you! > Its easy to say "we should just get rid of debt", but the issue there is that we know debt works, when used well, even over the long run. Think about it: If I want to open a business, there's no way I can afford that without Debt. So I take out $100k. In five years, lets say I've made $500k total This is the part where I fumble. In a society with 2 citizens and one bank, if citizen 1 borrows $100k, the maximum profit they can make = money borrowed by citizen 2. Three cases in the above example with 10% interest: 1. Citizen 2 doesn't borrow but instead just lives by hunting deer. Citizen 1 and the bank will go bust 2.Citizen 2 borrows 200k and spends 100k on something citizen 1 provides. Citizen 1 makes 100k profit and repays the loan with interest, say total 110k. Now citizen 2 is still on the hook for 220k. How will Citizen 2 get 220k if he has only 100k left and the other citizen has only 90k left? The only way I see it is they produce another kid who takes another loan. 3. Citizen 1 takes 100k loan, Citizen 2 takes 5k loan. Citizen 2 pays 5k to Citizen 1. Citizen 1 did not make enough to repay the 10% interest. So bank sucks it up and gets back 105k. Citizen 2 absolutely doesn't have any money to repay that 5k loan they took. So both Citizen 1 and 2 are busted. What now? They have to take more loans infinitely? (Short of producing other citizens who take loans) I would really appreciate your views.