The mighty Federal Reserve. It's more powerful than a ballooning housing market, able to stop inflation in a single bound. And, if it slips...
NEW YORK — The mighty Federal Reserve.
It’s more powerful than a ballooning housing market, able to stop inflation in a single bound.
And, if it slips, if it uses its super powers unwisely, if it goes too far, it could push the economy into recession with just a nudge of its pinkie.
That’s one way of looking at the nation’s central bank.
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Under departing Federal Reserve Chairman Alan Greenspan, it has become the main way.
The Fed is seen as the arbiter of all things economic, the capital of Moneyland, with Greenspan as its ruler and resident hard-to-understand genius.
With the chairman’s seat at the central bank expected to turn over to Ben Bernanke in January, it’s time for a reality check. Just how powerful is the Fed?
The Fed has two missions, said Quincy Krosby, chief investment strategist at The Hartford, the Connecticut-based insurance company.
Its primary mandate is price stability, keeping inflation at bay.
Its secondary charge is maintaining an environment of sustainable economic growth, which is interpreted to mean sustaining jobs.
To achieve its missions, the Fed has two main tools: It regulates the money supply and increases or decreases short-term interest rates.
More money plus lower interest rates are the tools of an “accommodative” Fed, a Fed trying to spark economic growth.
If the Fed decreases the nation’s money supply and raises interest rates, it is tightening, trying to slow the economy and stave off inflation.
After 12 rate increases in a row, the short-term federal funds rate is at 4 percent, a four-year high, and Wall Street watches the Fed with rapt attention. “We have said it before, and we shall say it again: The key to next year’s economic and financial market performance hinges upon the Fed not overreacting to the perceived inflation threat,” a recent Merrill Lynch research report said.
When the Fed released notes this past Tuesday from its most recent policy meeting, traders bid stocks higher after sensing a glimmer of hope that an end to the Fed’s rate increases was in sight.
Citigroup’s chief global equity strategist, Ajay Singh Kapur, quotes an old market adage, “Economies don’t die of old age, they are always murdered by the central bank.”
Eight of the past 12 recessions were preceded by Fed rate increases, he said, a figure that is mentioned and repeated often by the “all-powerful Fed” school of Wall Street strategists these days.
This is nonsense, said Sandy Lincoln, chief market strategist at Wayne Hummer Asset Management in Chicago.
There are factors that are far beyond the Fed’s control, Lincoln said, such as the introduction of the euro, the globalization of the economy and the current sharp increases in commodities prices.
“The Fed doesn’t murder economies,” he said. “The Fed doesn’t create these cycles. … They can get it wrong, but over the last 30 years they’ve gotten it right more often than they’ve gotten it wrong. At the critical time, they really got it right.”
While investors are growing impatient with the Fed’s rate increases, it’s important to remember that at the start of this tightening program, rates were at a 45-year low.
What the Fed is trying to do is take the air out of the housing bubble, slow the larger economy and see employment edge slightly lower.
“The key is a slowdown, not a crash,” Krosby said.