Whaddaya know - we're through another "crisis," at least for now. No, I'm not referring to the presidential election turned media circus. I refer to the quarterly panic of Wall Street over the possibility that the Federal Reserve Bank's Board of Governors might raise short-term interest rates a quarter of 1 percent.
It didn't happen. The panic, and the non-crisis, is over, for now.
Prior to the Fed's September meeting, the president of Boston's Federal Reserve branch bank opined that the federal funds rate would be raised by a quarter of 1 percent. The Dow, the S&P 500, and the NASDAQ dropped precipitously. The next day, a governor from the Fed's branch bank of St. Louis suggested that the Fed is in no hurry to raise interest rates. All three market indices rebounded.
Did even these bankers realize that they were so powerful as to sway markets by their mere suggestions? Most people never heard of these soothes, and even if they had, wisely paid them no heed. Only Wall Street and money managers paid attention and, as is their custom, overreacted.
We are to the point where good news for the economy is seen by Wall Street as bad news for the markets, and bad news for the economy is good news for markets. If this sounds irrational, it is.
It all stems from the ability of the Fed, chaired by Ms. Janet Yellen, to change short-term interest rates, a factor, not the only factor, and certainly not the chief factor, affecting the economy. This is said to make Yellen the world's most influential economist.
How did we get to this point? Let's unravel some of what appears to the average layman as mysterious, incomprehensible gobbledygook.
The Full Employment Act of 1946, signed by President Harry Truman, enshrined into law the national goal of full employment. It also created the Council of Economic Advisors, the chief responsibility of which is to advise the president on economic policy.
The two broad macroeconomic tools the federal government has to affect economic activity are fiscal policy and monetary policy. Fiscal policy is the taxing and spending powers of the federal government, the responsibility of the Congress and the president. Monetary policy is the influence of the nation's money supply and interest rates, the responsibility of our Federal Reserve System.
Most economists assert that fiscal policy is the stronger tool. Federal expenditures directly put money in the hands of businesses and individuals. Taxes directly cut spending power of the private sector. Many, if not a majority, of mainstream economists recommend increased government spending during recession to compensate for lack of private spending. During prosperity they recommend increased taxes to reduce deficits and curb possible inflation. But even during rising prosperity, raising taxes, whether to pay down the public debt, or anything else, is a tough sell.
The major problem with counter-cyclical fiscal policy as a tool of macroeconomic stabilization is not its economic efficacy, but its political contentiousness. Government taxing and spending has political implications far beyond its role in economic stabilization. As a result, fiscal policy has long been abandoned as a major bi-partisan tool for achieving full employment. President Barack Obama did manage to get a mild stimulus package passed during his first term. Although it was definitely a factor in getting us out of the Great Recession, it remains controversial, as do future stimulus programs.
Political implications aside, fiscal policy definitely has economic consequences, whether or not the intent was economic stabilization. For example, the most conservative Republicans in red states rejoice when awarded another federal contract, as it helps their local economy. But the controversial nature of government spending to promote full employment has deterred the use of fiscal policy for this purpose.
The abandonment of fiscal policy for achieving full employment leaves it to monetary policy and the Fed. The major tool of the Fed is the manipulation of short-term interest rates, a passive, and weak, tool at best. Nevertheless, this is what makes Yellen, presiding over weak tools at best, a "powerful economist."
What about the economists of the President's Council of Economic Advisors? As the title implies, their role is "to advise." They have no power of decision. But what about the president who they advise? As the old saw goes, "the President proposes; the Congress disposes." Congress controls the purse strings. The point is that while the president's economists advise, the Fed actually makes decisions, even if only on short-term interest rates, again, not a major factor, and certainly not the most important factor, in performance of the economy.
This is not to say that the Fed's decisions are unimportant. But the effect is asymmetrical. Keeping rates low is passive; it gives consumers and businesses latitude to borrow, but cannot make them do it. In contrast, raising rates can definitely curb spending and borrowing by businesses and consumers. This makes raising rates too soon potentially more harmful than keeping rates low for too long.
This asymmetrical effect no doubt partly explains the Fed's reluctance to "raise rates too soon." The consequences of raising rates and choking off growth are more severe than leaving rates low.
Back to financial markets, the Fed's actions of late have other consequences. With low rates of return on bonds and other fixed rate instruments, dividends on high quality stocks are attractive. With that, Wall Street sees rising interest rates as bad for stocks. Hence, good news for the economy is seen as bad news for financial markets.
Some economists suggest, however, that in retaining low rates, the Fed is overly cautious, leaving itself no arrows in its quiver to counter another recession should one arise. This, especially since a fraction of a percentage raise during economic recovery should not significantly curb economic recovery.
In any case, Wall Street reaction to potential small interest rate changes seems like another non-crisis.
- John Waelti of Monroe, a retired professor of economics, can be reached at jjwaelti1@tds.net. His column appears Fridays in The Monroe Times.
It didn't happen. The panic, and the non-crisis, is over, for now.
Prior to the Fed's September meeting, the president of Boston's Federal Reserve branch bank opined that the federal funds rate would be raised by a quarter of 1 percent. The Dow, the S&P 500, and the NASDAQ dropped precipitously. The next day, a governor from the Fed's branch bank of St. Louis suggested that the Fed is in no hurry to raise interest rates. All three market indices rebounded.
Did even these bankers realize that they were so powerful as to sway markets by their mere suggestions? Most people never heard of these soothes, and even if they had, wisely paid them no heed. Only Wall Street and money managers paid attention and, as is their custom, overreacted.
We are to the point where good news for the economy is seen by Wall Street as bad news for the markets, and bad news for the economy is good news for markets. If this sounds irrational, it is.
It all stems from the ability of the Fed, chaired by Ms. Janet Yellen, to change short-term interest rates, a factor, not the only factor, and certainly not the chief factor, affecting the economy. This is said to make Yellen the world's most influential economist.
How did we get to this point? Let's unravel some of what appears to the average layman as mysterious, incomprehensible gobbledygook.
The Full Employment Act of 1946, signed by President Harry Truman, enshrined into law the national goal of full employment. It also created the Council of Economic Advisors, the chief responsibility of which is to advise the president on economic policy.
The two broad macroeconomic tools the federal government has to affect economic activity are fiscal policy and monetary policy. Fiscal policy is the taxing and spending powers of the federal government, the responsibility of the Congress and the president. Monetary policy is the influence of the nation's money supply and interest rates, the responsibility of our Federal Reserve System.
Most economists assert that fiscal policy is the stronger tool. Federal expenditures directly put money in the hands of businesses and individuals. Taxes directly cut spending power of the private sector. Many, if not a majority, of mainstream economists recommend increased government spending during recession to compensate for lack of private spending. During prosperity they recommend increased taxes to reduce deficits and curb possible inflation. But even during rising prosperity, raising taxes, whether to pay down the public debt, or anything else, is a tough sell.
The major problem with counter-cyclical fiscal policy as a tool of macroeconomic stabilization is not its economic efficacy, but its political contentiousness. Government taxing and spending has political implications far beyond its role in economic stabilization. As a result, fiscal policy has long been abandoned as a major bi-partisan tool for achieving full employment. President Barack Obama did manage to get a mild stimulus package passed during his first term. Although it was definitely a factor in getting us out of the Great Recession, it remains controversial, as do future stimulus programs.
Political implications aside, fiscal policy definitely has economic consequences, whether or not the intent was economic stabilization. For example, the most conservative Republicans in red states rejoice when awarded another federal contract, as it helps their local economy. But the controversial nature of government spending to promote full employment has deterred the use of fiscal policy for this purpose.
The abandonment of fiscal policy for achieving full employment leaves it to monetary policy and the Fed. The major tool of the Fed is the manipulation of short-term interest rates, a passive, and weak, tool at best. Nevertheless, this is what makes Yellen, presiding over weak tools at best, a "powerful economist."
What about the economists of the President's Council of Economic Advisors? As the title implies, their role is "to advise." They have no power of decision. But what about the president who they advise? As the old saw goes, "the President proposes; the Congress disposes." Congress controls the purse strings. The point is that while the president's economists advise, the Fed actually makes decisions, even if only on short-term interest rates, again, not a major factor, and certainly not the most important factor, in performance of the economy.
This is not to say that the Fed's decisions are unimportant. But the effect is asymmetrical. Keeping rates low is passive; it gives consumers and businesses latitude to borrow, but cannot make them do it. In contrast, raising rates can definitely curb spending and borrowing by businesses and consumers. This makes raising rates too soon potentially more harmful than keeping rates low for too long.
This asymmetrical effect no doubt partly explains the Fed's reluctance to "raise rates too soon." The consequences of raising rates and choking off growth are more severe than leaving rates low.
Back to financial markets, the Fed's actions of late have other consequences. With low rates of return on bonds and other fixed rate instruments, dividends on high quality stocks are attractive. With that, Wall Street sees rising interest rates as bad for stocks. Hence, good news for the economy is seen as bad news for financial markets.
Some economists suggest, however, that in retaining low rates, the Fed is overly cautious, leaving itself no arrows in its quiver to counter another recession should one arise. This, especially since a fraction of a percentage raise during economic recovery should not significantly curb economic recovery.
In any case, Wall Street reaction to potential small interest rate changes seems like another non-crisis.
- John Waelti of Monroe, a retired professor of economics, can be reached at jjwaelti1@tds.net. His column appears Fridays in The Monroe Times.
