The Fed and the Markets

The Federal Reserve’s interest-rate increases aren’t having the desired effect of cooling off Wall Street’s hot streak.

Well, NSS.  There’s a hint there.

The Fed needs to stop trying to manipulate the market and go back to doing its job, maintaining stable price levels (controlling inflation to low levels) and achieving full employment (whatever that means.  And, the latter is wholly dependent on the former and so need not be an independent goal, but that’s a different story).

Manipulating the markets as a primary means of helping the underlying economy is a fool’s errand.  While the markets are very strongly tied to the underlying economy, they are not the underlying economy, and the lags between economic performance and market behavior are both too long and too variable for Fed market shenanigans to be useful for anything other than letting the Fed pretend it’s doing something useful.

In theory, financial conditions should serve as the conduit between the Fed’s monetary policy and the real economy. When the Fed lifts short-term rates, long-term rates should rise also and financial conditions should tighten.

This is misguided; see above.  Financial conditions should be set by the free market behaviors of market participants.  The Fed’s role, to properly execute theory, needs to stay within its mandate: set the framework within which the free market operates by controlling longer-term price level.  That’s the sum and total of the purpose of the Fed’s monetary policy and its relationship with the underlying economy.

The Fed should set its benchmark interest rates to levels historically consistent with 2% inflation (the Fed’s oft-stated target inflation rate), and then it should sit down and be quiet.

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