Going a Bit Too Far To Get It Right

September 06, 2023

Since the economic shock of the pandemic, the eyes of the financial world have been on the Federal Reserve and its attempts to stabilize employment, lower inflation, and provide a soft landing for the overall US economy. Speculation and second-guessing the Fed has been a common conversation for years, but those debates are likely to get more heated in the coming months spurring questions like: Did the Fed do enough? Did they do too much? Did they go too far in raising interest rates? Should they have acted differently?

So far, it looks like they got it right. They have navigated our economic jet more deftly than the European Union or China and may provide us with that wished-for soft landing. But that won’t stop the debate in the future.

Ironically, they may have to go a bit too far to hit the economic sweet spot and get it right. And this is where the 5th Century BCE Greek philosopher Zeno of Elea (490-430 BC) comes in. Famous for his series of philosophical paradoxes, one important one jumped to my mind, his paradox about measurement.

To measure something, how far from point A to B for example, one needs to first go halfway and then keep shortening the distance by half again and again. If one keeps cutting the remaining distance in half, one can get close to the end, but never actually touch the end.

If we use a tape measure to find the distance between two walls, we know when we’re at the other wall when we hear a small noise from the contact or feel the resistance of the other wall. If you think about it, that sound or feeling means we went too far. But without knowing the distance between the walls in advance, how do you know when to stop extending the tape? After you hit the other side.

The Federal Reserve operates on the same kind of principle and is working hard to get to the end. They have been making regular changes to policies and interest rates, and weeks and months after the fact they get data back (including inflation, unemployment, and GDP growth rates). They then must make decisions about whether or not to continue to raise interest rates and tighten monetary policy. Unfortunately, to receive the feedback that they went far enough will require that little noise or resistance from the other side. Like measuring a room, they will have to go a bit too far to make sure inflation has been mitigated.

Last week, we saw the unemployment rate begin to rise slightly, inflation has dropped significantly, and we are waiting to see if there is a real change in the GDP. These are the three key metrics the Fed is using to decide when to change their current policies. Based on the information coming in September, I believe that interest rates will stay stable or possibly go up slightly over the next six months, which looks like the right answer based on the current information.

The end, or just past the end, may be near.