MacroPolicy Space Models: Trump vs. the Federal Reserve: Part II

In a prior post (here), I concluded that Both Trump II and the Federal Reserve (the Fed) are right: Interest rates are too high and they can't be lowered given the economic uncertainty of Trump II policies. So, from the graphic of the Federal Funds Rate (FFR, the Fed's primary policy tool), interest rates need to get down to the attractor path from the USL20 model, but we are still way above the 98% prediction interval for the attractor path. From the perspective of Systems Theory, the attractor path graph brings up the question of how good a controller has the FED been historically?

From the perspective of Cybernetics, which likes to think in terms of control bands, the Fed has been an Erratic-Controller going sharply outside the 98% predication intervals for most of the Late 20th Century. Prior to 1970, manipulation of the Fed Funds Rate (FFR) had little impact.

There some very interesting departures from the Attractor path during the Late and Long 20th Century. Essentially, the Fed was an integral part of history during the period (see the Notes and the Readings): (1) The Vietnam War, (2) The Arab Oil Embargo, (3) The Great Inflation and the Volker Deflation, (4) The Great Moderation, (5) The COVID-19 Pandemic and (6) The Rebound (Post-COVID Inflation).

In order to evaluate FED performance, we need a model for predicting the Fed Funds Rate (FFR). I have three models, one driven by the USL20 model, another driven by the WL20 model and a Business-As-Usual (BAU) model. The USL20 model is a strong model (using the Akaike Information Criterion, AIC) but the model is unstable (I'll comment on that below) so I have used the WL20 model as input because it is stable and provides an interesting counterfactual path. The attractor path (conducting a free simulation starting at 1950) shows two periods: (1) The Pre-Volker Deflation (before 1980) and (2) The Modern Fed after 1980.

In the Vietnam- and the Oil Crisis-periods, the attractor path suggests that the Fed needed to do more, increasing the FFR to stop Inflation before it started. After 1980, the Fed was responding to World-System signals, manipulating the FFR to deal with crisis (a little late in 1990, during the Dot-Com Bubble).

In spite of reasonable policy prescriptions from the USL20 model and the WL20 model, the BAU model is still best given the AIC statistics. The model suggests agin (graphic above) that the Vietnam-period needed higher interest rates, but after that the model calls for a steady state FFR path.

What are we to make from the predictions of these three FFR models and the History of the Late (and Long) Twentieth Century):

Fed policy actions (at least the FFR) are erratic. All the models call for smoother policy responses. For political reasons, the Fed may feel it has to make strong (rather than gradual) statements.
The Fed seems to have found it's footing after the Volker Deflation, but then had to improvise through the Subprime Mortgage Crisis.
If the US Economy and the World System are reaching a Steady State, where there is strong political pressure to lower interest rates an stimulate growth (even though rates are close to the Zero Lower Bound, ZLB), the FED may be forced to use the BAU (or even a Random Walk, RW) model to avoid political pressure.

Do we have a good idea what drives Fed policy? I'm not sure. However, there is one more "Structural" model we can look at (AIC = -455.7) that creates a Cybernetic Reaction function for the Fed mandate and uses it to drive policy. I"ll look at that more in another post (here).

For the present, the future of Fed policy actions will be hard to predict but we can continue studying counterfactual alternatives and watch what happens in the real world.