I’m guessing that this must be a confusing time to be a central banker, what with the “appreciable downside risks to growth” and all.
One day your economy seems “likely to continue expanding at a moderate pace supported by solid growth in employment and incomes”, the next… you’re trying to “facilitate the orderly functioning of financial markets”.
I don’t envy these folks.
Imagine having the responsibility of helping to guide the world’s largest economy through the ups and downs of economic cycles.
Analyzing indicators, conferring with other Reserve members, more analyzing… All the uncertainty…
There must be times when you just feel like throwing darts!
Why not?
Some component of anyone’s future outlook has to be a hunch right? Well, maybe that’s how we got into this mess in the first place.
Either way, central banker or not, we’re all human and as such, subject to certain biases in our perception.
Whether it’s misinterpreting the implications of this month’s industrial production figures or simply charging another jet ski to your vacation home’s HELOC (you know, the one that still has some room on it), mistakes are made and usually faulty insight is to blame.
I hate to say it, but I think sometimes an “Achilles Heel” of being a central banker appears to lay in both being likely very affluent as well as holding a great degree of skill and willingness to digest the economy’s macroeconomic statistics when drawing conclusions.
Don’t get me wrong, you all know I love statistics, but I think this particular combination of attributes may leave a central banker detached a bit from what the ordinary person experiences making them more academic and possibly resulting in a lot of misguided assumptions.
Take for example the recent paper by Federal Reserve Vice Chairman Donald L. Kohn entitled “The Rise in U.S. Household Indebtedness: Causes and Consequences”.
It seems to draw the right conclusions, namely, that, as a direct result of financial innovations in the mortgage market and the housing boom, household debt (as a ratio of income) is higher than it’s ever been in history (and consequently the personal savings rate is at the lowest point) leaving many Americans more vulnerable to various economic shocks.
But yet, throughout the paper little bits and pieces seem to reveal an unrealistic bias towards rational action leaving the reader wondering what world Kohn is working in.
For example, witness this passage:
“In a (hypothetical) world with no borrowing constraints, households choose a path for consumption based on their expected lifetime resources, interest rates, and tastes. … Households also choose their portfolio allocation, determining the amounts they hold of different types of assets and liabilities consistent with their net worth.”
Instead, how about the following for a more realistic view:
In a world with no borrowing constraints, people borrow to the hilt, competitively buying as much of anything they desire, especially McMansions and eventually, after getting completely tapped out, pray desperately that they don’t lose they’re job.”
Here’s another doozy from Kohn’s paper:
“… an increase in house prices changes the composition of household portfolios and may induce portfolio rebalancing that involves increases in debt holding. In particular, households may borrow against their house to invest more in tax-deferred retirement assets.”
How about this instead:
“… an increase in house prices changes the composition of the things inside the house, particularly effecting consumer electronic devices, granite countertops, stainless steel appliances, whirlpool baths, and every manner of luxury food, beverage and tobacco item you can imagine.”
The paper goes on from there taking great pains to describe in vivid detail what for the most part is fairly obvious to most, concluding with, among other things, this seemingly sound assessment:
“The most important factors behind the rise in debt and the associated decline in saving out of current income have probably been the combination of increasing house prices and financial innovation.”
Unfortunately though, Kohn then closes with this sad bit of analysis:
“Although higher debt service obligations relative to income would appear to leave households more open to unexpected changes in income and interest rates, many macroeconomic shocks involve the demand for goods and services and tend to lead to offsetting movements in income and interest rates. Moreover, the increase in access to credit and levels of assets over time should give households, on average, a greater ability to smooth through any shocks.”
So, when the economy tanks, interest rates will come down and all the cash-strapped households will simply live to borrow another day…
Indebtedness solves indebtedness… The Feds mad invention. But, the music must stop someday… Right?
