The Canadian fiat system

Nick Rowe refers us to Scott Sumner, let's take a close look at the problems with the Fed:

http://www.themoneyillusion.com/?p=27943
"When inflation is above target you need to reduce the growth rate of the money supply (relative to the growth rate of money demand) enough to bring inflation back down to the target. It just so happens that the sort of policy that would reduce the money supply growth by an adequate amount is also one that will result in nominal interest rates rising in the short run (due to the liquidity effect) by roughly 150% of the rise in inflation. But that rise in interest rates is not why inflation falls back to the target path (it’s an epiphenomenon), it falls back because you’ve reduced the growth rate of the money supply relative to demand. Inflation falls back for monetarist reasons, not Keynesian reasons."

A little thought and we can see how the Taylor rules fails. John assumes the central banker is in DC and the credit banker is local to the retail store. But the retail store is not connected to a far away place, it is connected to the warehouse a few miles down the road. By the time retail prices are too high, the retailer has already banked his winnings, and raising interest rates makes him do more investment and less retailing. 

John has deliberately put a nine month cycle in the banker loop, using Congressional regulations. By the time the loop cycles the retail store owner is already in Hawaii, and is in the banking business.  To see the problem more clearly reverse roles. Make the retailer a government goods store in DC. Then make the retail banker Goldman Sachs with their own office at the New York Fed. Its the same problem reversed. By the time Congress makes an price adjustment, Goldman Sachs is already in Hawaii, in the government goods business.


That brings us to the Canadian system. They have a lend and deposit rate, and the difference is called the corridor. Move both those up and down, and maybe widen the corridor a bit to change response time. Then just accumulate the interest rates in and out, not the principle;  keeping the flow in target requires a thousand lines of code, open source even. Modify the corridor width the change principle balance levels. The only real responsibility is keeping loan defaults near zero. I doubt that they even know inflation, their regression will make them think so, but really inflation will follow the flow. Its a very simple system, something  a three year old could do with a mud puddle. 

What algorithm might a corridor system use?  I would try this one:

 This is my favorite differential equation. Let f be the ratio of the out over the in rate and then let f move along its trajectory.  The corridor width and in/out ratio will remain balanced so principle does not accumulate. Doing this, then, the third moment of out/in and the first moment will always be balanced by the flow momentum. I think this works, I am pretty sure the universe uses this so it should work for Canada. In its current form it may target a net flow of zero.  But a bit of a scale factor on f and it might just radiate a bit of the old NGDPs. Another game to play it to set the step size, trying to match the Krugman angle of specialization.  One should be able to derive a yield curve from it, and that should match the structure of the Canadian economy.