Response’s to Elon Musk’s statement on Fed’s Policy Decision
While @elonmusk’s statement seems to suggest that the Fed relies on lagged data when making decisions on inflation policy, it is worth considering the paper by Bernanke, B. S., & Boivin, J. (2003) titled “Monetary policy in a data-rich environment” published in the Journal of Monetary Economics, 50(3), 525–546. This paper supports Stock and Watson’s findings that the use of large data sets can improve forecast accuracy, and demonstrates that this result does not depend solely on the use of fully revised data, as opposed to real-time data. Furthermore, the authors estimate policy reaction functions for the Fed, accounting for its data-rich environment, and provide a test of the hypothesis that Fed actions can be explained exclusively by its forecasts of inflation and real economic activity.
The issue at hand is not the Federal Reserve’s policy decisions, as they are based on monetary theory and aimed at addressing rising inflation due to various factors, such as the war in Ukraine, increasing energy prices, and rising costs of food and commodities. The challenge lies in the ability of key players in the economic ecosystem to anticipate that interest rates, or the cost of money, will trend upwards for some time. Consequently, it is their responsibility to adjust their business strategies accordingly. For example, investments that heavily relied on treasury bonds with near-zero interest rates prior to the Ukraine conflict may now be considered outdated. At http://Geopolitics.Asia, our mission is to forecast future geopolitical developments and assess their impact on the economy and business environment. So far, our analyses have been accurate, such as predicting the downgrading of COVID-19 from a pandemic to an endemic (https://www.geopolitics.asia/post/could-kraken-s-goodbye-kiss-signal-the-end-of-covid-19), anticipating that the war in Ukraine would result in attrition warfare (https://www.geopolitics.asia/post/gray-zone-s-hybridized-power), and identifying the potential disadvantages Russia faces in the geopolitics of energy (https://www.geopolitics.asia/post/geopolitics-of-energy), which could potentially lead to its disintegration (https://www.geopolitics.asia/post/we-are-living-in-the-dangerous-time). It is the responsibility of C-level executives to thoroughly assess these analyses and adjust their investment and business strategies accordingly. Failing to differentiate between insightful decisions and mere conspiracy theories is regrettable.
To mitigate financial risk, banks can employ several instruments and strategies. For a bank with $200 billion in assets from deposits, it is crucial to manage investments diligently to prevent mismatches when paying interest to depositors. Typical strategies that banks use to balance their assets and liabilities include but not limited to:
- Asset-liability management (ALM): Implement a thorough ALM process to measure and monitor interest rate risk, liquidity risk, and credit risk, helping identify and manage potential mismatches between assets and liabilities.
- Diversification: Reduce risk and manage cash flow requirements by diversifying your investment portfolio across various asset classes, industries, and maturities. This approach helps mitigate potential losses and generate stable returns to meet depositor interest payments.
- Match funding: Invest in assets with maturities and interest rate profiles that closely match liabilities (deposits) to reduce the risk of interest rate mismatches and ensure adequate cash flows for meeting depositor obligations.
- Interest rate hedging: Use interest rate derivatives, such as interest rate swaps or options, to hedge against interest rate risks and minimize the impact of interest rate changes on your bank’s net interest income.
- Maintain a liquid asset buffer: Hold a portion of your assets in highly liquid, low-risk investments, such as government bonds or cash, to ensure quick access to funds for meeting depositor withdrawals or other liquidity needs.
- Regular stress testing: Evaluate your bank’s ability to withstand economic downturns or unexpected events by conducting regular stress tests. This process can help identify vulnerabilities and prompt corrective actions if necessary.
- Active monitoring and risk management: Continuously monitor market trends and economic conditions, adjusting your bank’s investment strategy accordingly. Establish a robust risk management framework to identify, measure, and manage various risks associated with your bank’s investments.
Regarding the concern about hiring a consultant for accurate geopolitical analysis and risk management strategy suggestions at a budget of $2–5 million per year, one might wonder how a bank with $209 billion in assets could possibly afford such an exorbitant expense. With the potential benefits and cost savings that expert analysis could provide, it’s baffling to think that investing in these services might be considered too expensive.
This statement has been published on my twitter’s thread, https://twitter.com/sikkha/status/1636983767847043074
