DS, Wow, now that is a detailed answer... Thanks, I am in awe... I have a lot to think about here...
Scott
Scott
Quoting DarkstarDislikedI read this book on the history of risk a few months ago and one of its chapters was on game theory. One of the examples they gave to explain the theory used Congress and the FOMC to highlight how opposing participants make choices based on their own priorities.
It’s easy to conclude that because the FOMC is a component of government, it works for the government’s best interest, but the truth is that governments (as well as financial markets) are still made up of individual participants. Each participant has their own agendas and aspirations and often those goals conflict with other participants in the environment.
Ben Bernanke and his ilk are judged on their ability to control inflation. It is etched deeply in their minds that stable, long term growth is a consequence of a low inflation environment and irrespective of what else is going on in the world; their priority is to maintain that objective.
Congress works from the perspective that the happier the constituents, the higher the probability of reelection. It would please the constituents immeasurably if the economy was overheating and inflation was driving up wages at an ever increasing rate. One of Congresses many tools is the ability to lavish their supporters with tax reductions while maintaining (or increasing) federal spending.
The majority of our current budget deficit is a direct result of this excess spending mentality. A byproduct is an ever weakening dollar position in world markets which has the nasty little side effect of increasing prices. If left unchecked this has a tendency to kick off the wage/price spiral that allows inflation to get out of control.
Knowing all of this, why should we assume that the FOMC would want to endanger their own priorities to support the Republican Party? That's really what you’re talking about. There is no risk of the November elections being canceled and as such, a weakening economy would only endanger the party of majority. It could easily be argued that the FOMC would be better served by the elections resulting in a Democratic majority. An increase in taxes would reduce the budget deficit (albeit temporarily) and the resultant strengthening dollar would reduce the inflation risks.
Before this blows up into a political discussion, let me say that the majority of the time I subscribe to the Republican ideals. I think if there was a socially liberal/fiscally conservative party I would be their staunchest supporter, but since there isn’t, I prefer the lesser of two evils. The above is not a diatribe of either political party and examining it in that light would only detract from the discussion.
In summary, I believe it would be dangerous, and borderline foolish, to assume elections have any baring on monetary policy decisions.Ignored