It’s All Relative Janet

As I have said before (and will probably have to say a million times more), despite the obvious intellectual advancements made in more progressive sciences, economists continue to utilize what we might call a Newtonian Framework that they build their economic models upon. This framework is one in which it is assumed that our economy is much like a giant machine that can be analyzed, understood and modeled. That there are specific forces at work in our economy, and that human beings respond to these forces in much the same way that Newton proposed that planets and stars reacted to the physical forces in our universe.

Just as this type of framework misled Newton into thinking of the universe in terms of absolute space and time, economists continue to be misled into thinking of our economy in terms of economic absolutes (ex: saving is always good for the economy, lower interest rates will stimulate demand). The reality is that we live in a Relativistic world that can only be understood by looking at the relationships that exist in our world.

Because economists do not understand this, it is not at all surprising to routinely here idiotic comments coming out of the Fed. One of the more recent examples is the internal debate going on in the Fed over when they should begin financial “tightening” in order to keep the economy from overheating. If economists understood that interest rates are all relative, then they would understand that the Fed has actually been “tightening” for years.

Let us assume that the Fed Funds Rate is currently set at 2%. Would you consider this rate to be “loose” or “tight” (financially speaking)? The only way to answer that question would be to look at where market interest rates stand.

If current market rates were near 10%, then we would describe the Fed Funds Rate as being “loose” or “accommodative”. If, however, market rates were near 3%, then we would describe the same Fed Funds Rate as “tight”.

Since the Fed implemented its Fed Funds Rate of 0% back in 2009, market rates have essentially been cut in half. Thus by keeping the Fed Funds Rate constant in a period of declining rates, the Fed was effectively “tightening” the entire time. I guess it shouldn’t be surprising that the Fed doesn’t understand this. After all, they did lead us straight into one of the worst financial disasters in history.

#EconomistsAreMorons