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Fed Policy-Opposing the Stock Market

 
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arthur
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PostPosted: Sat Apr 02, 2005 5:13 pm    Post subject: Fed Policy-Opposing the Stock Market Reply with quote

The Federal Reserve works in the future economy. Currently, the Fed foresees a likely acceleration of inflation, although inflation is currently not a problem. Actual inflation is past inflation and expected inflation. So, if inflation expectations rise, then that would add to future inflation.

The U.S., the largest and most technologically advanced economy in the world, can expand at about a 2.8% real annual rate over time. A faster rate cannot be sustained. Recently, the U.S. economy has been expanding at over a 4% real annual rate (see link below).

http://www.bea.doc.gov/bea/newsrel/gdp_glance.htm

The weaker dollar is beginning to spur export growth, employment will continue to pick-up, and fiscal policy is stimulative. So, above trend growth will continue, or perhaps pick-up, unless action is taken to offset some of the expansionary policies. Consequently, the Fed has embarked on a policy to slow the economy, by using the tool of "Jawboning" to manage the "Wealth Effects" in financial markets, which influence the economy.

Therefore, the Fed, and through the FOMC, will likely take a more aggressive tightening stance later this year. Ideally, the Fed would like financial markets to slow the economy, through negative Wealth Effects, rather than actually ramping-up money tightening. However, if Jawboning is not effective, then the Fed will take stronger action to keep a lid on stock prices. The Fed, I believe, wants to preempt a pick-up in inflation and output, and slow the economy to around 3%. Unfortunately, the Fed often "overshoots" its targets. It'll be a tough balancing act. However, the Fed will not be a friend to the stock market this year.
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