Sunday, July 27, 2014

Central Banking: Janet Yellen on Monetary Policy and Mechanical Formulae, How Much Predictability Is Too Much Predictability?



Is Janet Yellen's response as straight forward as it should be? Is that rabbit hole shallow or deep enough to peek into?

I can only assume what the underlying repercussions are to even entertain the thought of submitting the exercise of monetary policy decision making to the rigidity of formulas. Machines can't be qualified, no way, can they add numbers (*sarcasm*)?! *(Side note, I have recently discovered that up to this day and age, there is still truth to how Filipinos can lack the sarcasm gene and I think poor literary exposure warrants the use of the *sarcasm* mark to help our disabled and unfortunate countrymen)

I suppose the synthesis of data to give the optimal decision on whether to raise, cut, or hold key interest rates can be delegated to some evil Skynet that will in term dictate the economic tone of the environment which citizens will have to deal with. (*s*) The possibility, however, if put on the table for consideration posits many questions in my mind, to be honest.

What are the underlying arguments for using mathematical formulas to set central bank interest rates versus using human discretion on empirical data instead? What is the impact of predictability to the inherent nature of financial markets vis-a-vis risk-taking and return-searching? 

When Federal Reserve Chair Janet Yellen said, "...this procedure would 'essentially undermine central bank independence in the conduct of monetary policy,'" what did it really mean to her?

When central banks monitor price stability and ensure moderate inflation rates, how can "shock value" (surprise factor -> actual decision is not equal to expectations/forecasts) influence monetary policy efficacy when compared to smoothened yield curve predictability? 

Does this dis-empower central bank relevance, importance, and influence among financial market players and, ultimately, the economy? How about the relevance of economists and financial market analysts who spend time refining models to predict central bank decisions?

In view of the Theory of Speculation (Louis Bachelier, 1900), is it still possible to make money if everyone (buy side or sell side) knows what's going to happen to an asset/interest rate in a given point
in time in the future? 

As the chicken or egg argument would go, are rate movements influenced by what the central bank broadcasts to market participants or are rates determined by what market participants do (put their money where their mouth is through financial markets) in anticipating/speculating what a central bank will do with interest rates?

Central banking has always been quite the balancing act, even despite the official principle of apolitical professional practice (1951 Accord), 

lest each central bank ends up destroying its own economy ala-Zimbabwe by letting populist politicians order central bankers around regarding monetary policy. 

In my opinion, somewhere between the lines of Yellen's testimony, the exercise or even the idea of risk-taking in itself is an essential component to ensuring market liquidity. In my mind, this idea is already trudging on the anthropomorphic reliance of financial markets to human emotions of decision makers - philosophically, psychologically, and/or sociologically intertwined with hope/greed and despair/fear as facilitated by the never ending churning of commerce and "efficient" allocation of money (value) to where decision makers think are the "optimal" or "best" choices. Interestingly, buyers entering and sellers exiting positions obviously have deviating beliefs, which precisely goes back to my whole argument of what "risk taking" means in the exercise of investments among market professionals and financial market practitioners, whether this is out of genuine necessity to play a
crucial role in society or merely some self-important/self-justifying designation to (high paying? *shoulder shrug*) jobs that can be done better by mathematical equations executed by machines/computers in most cases anyway.

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