Macroblog reports that the markets are unusually uncertain about where the fed funds rate is heading. Could it be that one reason for this is that the Fed faces a version of Newcomb's problem?

To remind you, the problem is as follows.

A super-being, with amazing powers to predict your behaviour, offers you two boxes. In one, there is $1000 for certain. In the other, there is either $1 million or nothing.

The being offers you a choice: to take only the $1m or nothing box, or to take both boxes.

The catch is that he put the $1m into the box yesterday only if he has predicted that you'll take that box alone. If he predicted that you'll take both boxes, he left it empty.

What do you do? There are two theories.

Evidential expected utility: I must take only the one box. The super-being has predicted that I'll do this, and has kindly put $1m in. If I take both boxes, he'll have predicted that too, and put nothing in the box, so I'll have only $1000.

Causal expected utility: The $1m is either in the box or not by now. My choice won't affect the contents. So I must go for both boxes. That way, I'll pick up $1000 for sure, with a chance of the $1m.

Everyone's argued the toss over this puzzle for ages. The message Robert Nozick - who brought the puzzle to wider attention* - took from it is that there are two valid but contradictory ways of taking decisions. Rationality is not the clear-cut concept we think it is.

What's this got to do with monetary policy?

Plenty. The Fed could think like this.

Evidential expected utility: if we hold off from raising rates, the private sector will take it as a signal that we - the experts - are worried about the economy. They'll therefore start worrying too, and cut spending and investment. We'd better raise rates rather than surprise people.

Causal expected utility: A rate pause will simply cause the economy to be stronger than it would be if we raised rates. So let's take out a little insurance against the possibility that Katrina will have serious effects on activity. That's Macro 101.

Two decision rules conflict.

If you think this is absurd, consider this paper (pdf) by Andrew Caplin and John Leahy. They describe a model in which private agents respond to interest rate cuts by cutting spending, because they anticipate more economic weakness and rate cuts, with the result that gradualist monetary policy is counter-productive.

And if you think this is tricky, here's a further wrinkle. Causal and evidential rationality, said Nozick, are not the only forms of rationality. There's also symbolic rationality; some things (like voting?) are worth doing not because they make us materially better off, but because they symbolize who we are.

Introducing this form of rationality gives us a further dimension to the Fed's decision. Does it want to symbolize that it's keen to fight an inflation threat, or that it's sympathetic to those hurt by the effects of Katrina?

It's no wonder the market's confused.* * in this superb book. FWIW, I reckon too many people are Nozickeans because of Anarchy, State and Utopia, and not enough are Nozickeans because of this. *

Favourite bit of Nozick outside (I think) of AS&U is where he said that Thrasymachus's mistake was that he should have beaten Socrates up to prove his point.

Posted by: Blimpish | September 13, 2005 at 05:34 PM

The Fed Raises Rates As The Inevitable Yet Futile Tool Against

the Coming Deflation - the Current Fractal Analysis.

The weekly count for the third of three sequential major

growth fractals dating from 2003 for the Nikkei and Hong Kong indices

is 10/25/20. For the western US-Euro equities the weekly fractal

sequence of this final third fractal is 11/26-27/22. The two different

eastern and western equity indices weekly sequences conform to an

idealized x/2.5x/2x pattern and have reached their respective apogees

in very same week. While the Nikkei and some of the Euro-indices have

shown very characteristic exhaustion gaps within the past 3 trading

days matching the multi-yearly blow-off patterns of the high flying

NYSE and AMEX equities, the collective US Wilshire has not been able

to best its August 3, 2005 apex.

The underperformance of the premiere summation American Index, the

Wilshire 5000(TMWX), reflects the disproportionally negative

integrative burden on the US macroeconomy of its valuation fractal

determining elements - total quantitative personal, governmental, and

corporate debt, the latter of which has become much more expensive to

service under some behemoth's new junk bond status; unpayable private

pension funds soon to assumed by American taxpayers- of formerly

great, soon to be bankrupt, US corporations; expensive war cost which

have historically withered every prior major overextended world power,

record lack of US collective personal savings used as a base for

fractional lending, exhausted consumer discretionary spending running

up against near record energy costs; outsourced high paying jobs and

current wages not maintaining pace with inflation and debt servicing;

siren enticing and predatory unregulated lending practices leading to

asset consumption by a new group of extremely marginal buyers; rising

short term interest rates; the cresting of valuations of the US ATM -

equivalent asset, i.e., housing overvaluation; and recent massive

forward consumption of corporate profitless US automobiles akin to a

python eating its semiannual one time big pig bolus meal.

Relative to other leading world countries' above listed internal

economic parameters, the US and its protégée, the Wilshire, couldn't

exhaustion gap its way above its collective 3 August 2005 high. This

provides high probability information about the relative summation

strength of the US economy and its expected future asset valuation

activity in comparison to other world economic competitors.

From the Economic Fractalist archive on 28 July 2005:

Reverse Growth Fractal Top Patterns - Another Confirmational Indicator of

the Finale for the 147 year Second Great Fractal

'At major lower order valuations, top quantum units in individual equities

and commodities, many times complete classical inverse growth fractals. The

time units of the inverse top fractals can be in minutes, hours, or days

and usually are in a quantum sequence of either x/2.5x/2x or

x/2.5x/x,1.5x,1.6x,2.5x, the former being much more prevalent.'

A weekly reverse growth fractal of 15/37/30 weeks or x/2.5x/2x was identified

as a possibility on 28 July 2005. At the same time the possibility of a

x/2.5x/2.5x sequence was identified. This week, which ideally

completes a 15/37/37 week or ideal x/2.5x/2.5x inverse growth fractal

sequence, is in exact synchrony with the termination of a

11/26-27/ 22 of 22 averaged fractal weekly growth pattern.

Tuesday September 13 was day 26 of a 28 day ideal second fractal decay

pattern. Wednesday and Thursday, 14 and 15 September 2005 should

ideally be down days for the Wilshire ending the second decay fractal

of 28 days of a three sequence : 11/(28 of 28)/ 28 ideal daily decay fractal

pattern. An ideal next high for the third and final decay fractal would be on

day 104 of a 52/130/96(day 96 =Tuesday13 September) of a 104 day

sequence. The ideal final high of this nearly identical 1929 decay fractal

pattern would be on day 7 of a 11/28/(7 of 28 )day sequence. If the fractal

pattern identification is correct the last 28 days representing the third decay

fractal will be the major primary crash sequence equivalent to the final third

fractal of 27 days seen in the fall and Fall of 1929.

If the AMEX and NYSE characteristic exhaustion gap highs on

Friday 9 September remain unexceeded, a very ideal daily sequence

of 52/123/100 which when averaging, integrating, and reconfiguring the first

two fractal sequences of 52 and 123 days becomes 50 and 125 completing

an ideal 50/125/100 daily with a perfect x/2.5x/2x averaged configuration.

Gary Lammert http://www.economicfractalist.com/

Posted by: gary lammert | September 14, 2005 at 03:36 PM