The Federal Reserve (2)

Jia Han
Aug 5
3 min read

After reading the Federal Reserve (1), one might think that the Federal Reserve’s job is quite simple: obtain data (i.e., economic indicators such as GDP growth), study them, and then change the interest rate accordingly. In reality, its job is very challenging. The US economy (or any large economy) consists of many millions of economic entities (individuals, families, corporations, firms, etc.). Each such entity has its character, financial situation, and goals, and each will make its own decision. Furthermore, any data set at a given time is only a snapshot of the system; this data set is constantly changing. Interpreting the data set and making decisions in order to achieve stability is difficult. There are no fixed, universal rules or laws for the Fed Reserve to achieve its goal, which is to keep inflation within the range of 2-3%.

I have written a series of write-ups [1-4] for political or economic systems from a philosophical and biblical viewpoint. It serves a top-level overview of a large economy. In [4], I mentioned that the 1997 Nobel Prize in Economics was awarded to Robert C. Merton and Myron Scholes for proposing a mathematical formula to evaluate stock options values. They then started a firm (LTCM) to apply the formula to the market. Initially, the firm was successful, but later collapsed and almost brought the market down with it. From a biblical viewpoint, its failure is certain, known as “writing on the wall” (Book of Daniel, chapter 5). The Bible says that it is impossible to know human nature with certainty. Ecclesiastes 3:11…… He has also set eternity in the human heart; yet no one can fathom what God has done from beginning to end. How can you express or model infinity, mathematically or otherwise? You cannot. It is even more difficult to model a nation of many people, each potentially having something infinite.

On the other hand, it is possible to reduce the severity of economic cycles. The Federal Reserve (or central banks of other nations) was created for this purpose. WSJ produces a short video to explain the Federal Reserve [5]. It is very good. Please watch and understand it.

There are three points to supplement [5]. [6-8] provide more background. (There are respected economists who advocate abolishing the Federal Reserve. There are pros and cons for each choice. They are too involved to be considered here. Furthermore, they are not practical at present.) What I can say here is that if the Federal Reserve is managed well, it helps the economy. But if it makes the wrong decision at the wrong time, it may cause disaster, such as the 1930s.

The second point I wish to make is the independence of the Federal Reserve (which mentions briefly in [5]). All presidents wish good economic performance, which might be interpreted as good economic policies and credited to the current president. If a President wishes to be reelected, a high performing economy is of great help. Even if a president is not seeking reelection, a good economy helps his legacy. Therefore, all presidents want low interests. However, interests could be too low, which turbo charges the economy. An overheating economy is likely to cause inflation.

The third point is not directly related to the Fed Reserve but is important to the future of the American economy: dealing with government debt and deficit. The US debt has reached a dangerous point. I first saw this in [9]. Niall Ferguson has addressed the debt problems in several presentations (e.g.[10]). He also has written a paper [11]. Other well-known scholars also expressed concern about this issue. Although debt is not directly related to the Fed Reserve, policies of the Fed Reserve could have important implications to the debt. I shall discuss the above issues in the future.

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Philosophy, Sciences, Religion

The Federal Reserve (2)

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