Is the Fed a Trader?

I read the following article at the CATO Institute, which got me thinking... Isn't the Fed essentially a trader now? Just about once a month (assuming no inter-meeting action) they make a "trade" on interest rates (raise, lower, hold) based on the current information. The decisions they then make set the country on an economic course.

But, what if the time frame is just too short between meetings? We know based on all evidence the shorter the time frame we make between a decision the more likely that decision is going to be flawed. Yes, I know the Fed is filled with a bunch of smart folks with Ph.D.s but history also tells us the number of letters following a name has no correlation to the ability to avoid making spectacular mistakes, only the ability to explain them away after (Mr. Greenspan?).

What if the Fed was only allowed to meet and make rate decisions quarterly? Berkshire's (BRK.A) Warren Buffett famously said that if an investor was only allowed to make ten investing decision in their lifetime, he was confident the overwhelming number of them would make far better decisions and be successful. One could say that perhaps because investors now know the Fed can almost be bullied into making inter-meeting decisions, they create the conditions needed to force it.

If that ability was taken away, then would we see less volatility? I'm becoming convinced the huge volatility we have seen for the past decade and the increasing activity of the Fed during that time span are not totally correlated. It is a chicken vs egg scenario. Is the Fed activity a reaction to events, OR, are the events a reaction to Fed activity? I am leaning towards the latter.

Why are we to believe that the Fed making an almost monthly interest rate decision is any better for the economy than if they were only allowed to do it quarterly? It would place far less emphasis on "today's" news. It would also lengthen the myopic focus of the market of what the Fed will do next week.

This is especially true when most of the actions from the Fed have no real effect on the economy for many months down the road. This means the Fed is then making another decision without any actual evidence whether or not the first decision was the correct one. Actually, they then make several more decisions without knowing if the first one was correct.

We then have the scenario where the investing public en masse starts speculating on the effect of all the current decisions on the economy. Again, all this happens with no empirical evidence of whether or not any of the decisions were correct or not. That leads to a mass mentality and the boom/bust cycles we seem to be jumping in and out of.

I'm not sure a commodity peg would solve the problem either, but I'm pretty sure no one can make "long term decisions" on a monthly basis without any quantifiable feedback...

I do think we need to make some changes though as the booms and busts differ, but Fed activism remains the same.

Comments

[Moon Kil Woong:]

The US is acting like China's economy where all economic activity is at the beck and call of what government says and how much free candy they shell out (lower interest, stimulus programs, bailouts, government sponsored buyouts and dealmaking). About the only thing they have that we don't these days is price controls. You can no longer call it a free economy and you can no longer call the markets as reflective of anything but government manipulation.

As things are going these days I wouldn't consider buying until the market hits 3,000 and the government has decided that there is nothing more they can do to mess up the economy. That is , provided they haven't made the dollar worthless or caused de-leveraging that had caused 75% of all the dollars to disappear into the bank's do nothing incineration box (which is where TARP is going).

2008 Nov 18 05:29 AM

[Smarty_Pants:]

Not just quarterly, permanently. Why not just get rid of the FED altogether and let interest rates be set by agreement between borrower and lender?

2008 Nov 18 09:58 AM