November 3, 2014

The Federal Reserve

So lately I was pondering the role of the Federal Reserve.   I was in question over how accurate the setting of interest rates are and the consequences it had on markets. As I read through numerous articles and papers I realized that the Federal Reserve encounters numerous flaws in its applications.

One finding is that as the Federal Reserve sets interests rates it interferes with consumer behavior. The natural outcome of markets becomes altered due to government intervention.  With low interest rates in place it will cause unnatural amount of spending, regardless of what the market is in demand for.  This in consequence could potentially cause an artificial bubble and high inflation.  The potential effect of setting the wrong interest rate could be detrimental in the interaction of markets.

Furthermore, the Federal Reserve’s methodology in controlling interest rates is on the fundamental measurement of inflation. Though there lays hard tasks in setting the interest rate accordingly to inflation.  Firstly, the problematic scenario of predicting future interest rates. This is an issues due to the effect of postponed inflation.  The economy can be moving in a certain direction but the measurements don’t pick up on it until it’s too late. So we cannot have a true measurement of the current or the inflation at any single point. Secondly the fed makes its analysis on future inflation by accounting in aggregate demand measurements.  Aggregate demand measurements does not tell you the hidden values and does not give you a true indication of where inflation may be heading.  This means that the fed has no accurate way of either tracking or predicting inflation and in consequence are not able to set interest rates appropriately.

The Austrian point of view believes in interests rates set by market demands. The market itself will find the interest rate needed to effectively create a balance in the market.  This way it won’t interfere in the market process and the process will find its natural course.  

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