Re: Money Supply, Credit Supply

From: Mason A. Clark (masoncNOT_at_THISix.netcom.comQQQ)
Date: 06/26/04 

Date: Sat, 26 Jun 2004 19:00:26 GMT

On Fri, 25 Jun 2004 15:35:49 GMT, William F Hummel <wfhummel@comcast.net> wrote:

>On Fri, 25 Jun 2004 06:44:33 GMT, Mason A. Clark
><masoncNOT@THISix.netcom.comQQQ> wrote:
>
>>I didn't mean to say that supply and demand determines the "Fed" rate.
>>
>>"The interest rate banks charge on loans to the public": surely *this* is
>>determined by the law of supply and demand. For example, the public
>>buys fewer houses if the interest rate is higher -- can't afford more.
>
>The interest rates that banks charge is a mark up from the what they
>have to pay to acquire reserves from the Fed.

Assuming someone wants the money at that rate, in view of the fierce
 "competition among lenders."

> So interest rates can
>rise when demand is high, but they won't fall below some limit
>determined by bank profit margins.
>
>However in general, banks are price setters and quantity takers
>because the competition among lenders of all types is fierce.

With fierce competition, how is "price setting" possible? Collusion?
Surely not the law of supply and demand.

> Banks
>set their rates and the public decides how much it wants to borrow at
>those rates. The supply of credit money is limited only by bank
>capital, which is generally not a limiting factor.
>>
>>The Fed wants interest rates to be lower so the demand will be
>>higher and get us out of recession -- it is the law of supply and demand
>>that makes this work.
>
>True.
>>
>>A recession causes businesses and the private public to reduce their
>>demand for loans. Therefore, in due course, the price of loans must
>>fall. In that due course the Fed will observe the falling rate and
>>adjust its own rate. (proudly announcing it lowering (controlling) the
>>interest rates for the benefit of the public and alleviation of recession)
>
>Not true.
>
>William McChesney Martin, who was Fed chairman from 1951 to 1970,
>famously said: "the job of the Fed is the take away the punch bowl
>just when the party gets going." That was during the era of low
>inflation and high GDP growth rate.
>
>Then came the stagflation era of the 1970s, when both interest rates
>and the inflation rate began soaring. In 1979 Volcker started raising
>the Fed funds rate still higher to kill the inflation and that threw a
>monkey wrench into the economy. But even though the economy was in
>severe recession, he found that he had to keep raising interest rates
>to historic highs before the inflation rate finally turned around.
>Obviously the interest rate was not based on supply and demand then.
>
>The Fed has learned that the lag between a change in monetary policy
>and the response of the economy is typically 12 to 18 months. So it
>now has its staff modeling the economy with the objective of
>projecting ahead by a year or two. That has proven to be only a
>modestly reliable guideline, so it is used by Fed as just one of the
>inputs to monetary policy decisions. But the forward looking part
>remains in its decisions.
>
>The point is that the Fed, for better or for worse, is in the driver's
>seat on current interest rates. But it is not responding to current
>conditions so much as in projected future economic conditions. In
>particular it is concerned with the key macro variables, inflation
>rate and unemployment a year or so ahead. The notion that interest
>rates are set in response to current supply and demand may be true
>locally, but not true in a macro sense.

This makes me dizzy -- going in circles. The Fed, "in the driver's
seat," forecasts that interest rates are going to rise, therefore it
raises its own interest rate. Then the public interest rate rises because
of the Fed action. Uh.... which is the chicken, which the egg?

Whether by observation of the actual, current rate or by means
of a prediction, the Fed is *following*, i.e. obeying, the rate that
is determined by the economy -- determined by the law of
supply and demand or whatever. It is a race to see who's in
control. It doesn't matter how the Fed makes its decision.

The Fed's influence, to say nothing of "control" is minimal, granted
that the Central Bank has the power to so screw up the system as
to end any upward trend. Volker *may* have done this when he *followed*
the upward trend of interest rates so vigorously as *perhaps* to have
deserved credit for ending inflation. But without Volker the system would
have done it anyway. We live in a world contaminated by post hoc ergos.

>>
>>The mental picture of the Great Central Bank in all its Glory sitting
>>at a control panel managing the economy has been well planted in us.
>>
>It sure isn't my mental picture.

But you seem to insist that the Fed controls interest rates. If the Fed
can control interest rates surely it can manage the economy. It cannot.
>>
>>Unfortunately, the economy has its own plans and obeys its own laws.
>>The Fed is a good observer and *follows* the laws.
>>
>Which implies we could replace the Fed with a computer, right?
>>
This has been seriously proposed by serious economists. But the
Fed governors strongly resist loss of their jobs. Outsourcing may
be the better choice. Let Bangalore set the Fed rates. After all,
didn't Milton Friedman recommend a rigid formula?

>> Mason C now -- if we just could know those laws...
>
>But I thought we understood the law of supply and demand.

I don't. For a start, I would replace "law" with "influence."
Don't get me started on this one -- the role of supply in
influencing demand, advertising, price leadership, government
controls -- no -- "influence." "Law" my foot.

            Mason C enough of this... let's get back to Iraq

everyone seen Michael Moore's latest?

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