Unintended Consequences – Distortion of Decisions

Central bankers have tools to help the economy, but for the most part, those tools all have the effect of lowering interest rates.

But there are consequences of overriding the market to change the price of something.  The consequences are that every decision that uses the information from the affected market prices will be distorted.

Interest rates are a price for deferral of receiving cash.  Low interest rates signal that there is very little risk to deferral of receiving cash.  So one only has to pay a little extra to pay later rather than now.

This is helpful in stimulating consumption.  People without the money right now can promise to pay later with low penalty for the deferral.

But is the risk from the deferral really lower?  The interest rates are very low because the central bank is overwhelming the market demand.  Not because anyone really believes that deferral of receipt of cash is low risk.

But anyone who simply uses the market interest rates is having their decision distorted.  They are open to taking deferral risk without expecting to be reasonably compensated for that risk.

To purists who believe that the only usable value is the market price, this is the only real information.

But if you want to make good decisions about transactions that stretch out over a long time, you might want to consider making your own adjustment for the risk of deferral.

Explore posts in the same categories: Enterprise Risk Management, Risk

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