What Is The Role Of The Federal Reserve?

Chairman Powell of the Federal Reserve has been getting a lot of bad press about his actions being too late, not being enough, or being too heavy handed regarding the US economy. The commentary is from everybody. These comments are perhaps correct from their vantage point, but we don’t sit in his chair. Things may look different from there. It is difficult to be the chairman of the Federal Reserve and have perfect 20/20 sight forward. The Fed has more considerations than simply any one factor. So, although the comments may be quite accurate, we also should think about if we were in his chair, how we would we have behaved. It’s not entirely clear that in his position, we would have done exactly what everyone else has said, how he should behave, and when to execute those changes.

The Federal Reserve has two mandates:

• Mandate 1: Full employment
• Mandate 2: Price stability

Full employment is however that is currently defined. Price stability means prices are fairly anchored and fairly constant.

The word anchored is very important as they look back at the last 40, 50 years, in regards to inflation. The Fed thinks about inflation in the same manner individuals think about inflation. Take you, me, all our family members, for example: How do we think about the future of our prices? If we believe this item that we want to purchase is going to go up by 15% next month, and we need it, we will most likely buy it now. Why should we wait another 30 days?

That is inflationary: We would rather buy it now even though we may not need it at this very moment, but because we know prices are going up.
This is essentially hoarding. Hoarding is a type of practice that will cause inflation.

We purchase because our expectation about inflation is no longer anchored. Our expectation, is not at a specific number, our expectation is based on worrying.

The Fed wants to do everything they can to make sure the inflation is anchored at 2%, 2%, not 5%, not 8%. They don’t want it to go up from 2% because once you move away from 2%, The Fed does not know where it will anchor. That’s when people start spending more money buying future goods in today’s dollars. And that in and of itself, fulfills the prophecy of inflation.

So why is The Fed aggressively raising rates?

1. To show the public that they mean business about price stability.
2. To ensure the anchor remains anchored.

Additionally, we think the Fed is trying to front-load the rate increase, really ratcheting up the increases now. We have gone around 80 years without a 75-basis point increase. We’re going to do it again, another 75-basis point, and we’re going to keep going until they start seeing the economy slow enough and unemployment starts going up enough to dampen the enthusiasm about the economy. That is what they are trying to do to show that they mean business.

We believe one consequence of this is that the Fed is not going to be there when the stock market crashes. We believe this will be one of the first times in a long, long time that the Pavlovian response that the investors have, “Oh, boy, when the market drops, don’t worry, buy on the dips because the Fed is going to come in and save us all,” will not happen.

We believe that when the stock market drops, the Fed is not coming in to put liquidity into the market because they’re trying to do the opposite. They are trying to reduce the froth in the system. We believe the Fed’s actions are going to be different than what they have done for the last 20 to 30 years.

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