SEARCH BLOG: FEDERAL RESERVE
The economy is big, it is complex, and it doesn't show it's hand right away. It is the financial version of climate.
Every once in awhile, some major event will create a disruption in both systems. A volcano erupts; oil prices skyrocket. When that happens, we have a choice: try to enact emergency measures to counter the event or sit back and wait until a new state of balance is achieved. Of course, some events... an asteroid impact or a world war... completely change the system.
The Federal Reserve has chosen to try to address every fluctuation in the economy as if it were a major event. It is possible that the housing market collapse, followed by the banking crisis, concomitant with the run-up of oil prices is the financial equivalent of a small asteroid impact. But if we examine the sequence of events, we can see that the Fed may have overreacted several times in this decade... causing or greatly contributing to the very situations it then tried to correct with further reactions.
Imagine driving a car the way the Fed drives interest rates. The first step is to remain very close to the vehicles ahead. That way you know instantly when something is happening and can react very quickly. If the vehicle ahead slows down, you slam on the brakes and, if the vehicle ahead speeds up, you slam on the accelerator. The people behind you do the same thing. You put a lot of wear on your brakes and you use a lot more gasoline than you might have to, but you get to where you are going.Sure, driving interest rates is a lot more complex than driving a car... or is it?
Of course, the choice to back off and allow a larger space between your car and the vehicle ahead is rarely considered. The minor slowdowns and increases in speeds that now cause you to overreact would simply manifest as increases and decreases in spacing while your speed held fairly steady. If you did have to change speed, it would be gradually and a small amount. And you might find out that those mysterious traffic jams caused by "rubberbanding" suddenly go away.