Apr 26, 2019 4 min read

This week, we are going to take a detailed look at the Federal Reserve.

Treasury Secretary Alexander Hamilton came up with the idea for the Fed in the late 18th century. The central bank would oversee the country’s monetary policy, which would govern things such as interest rates and money supply. This differs from fiscal policy, which Congress controls through government spending and taxes. Both types of policy work together to either stimulate or constrict the country’s economy.

Hamilton’s first federal bank lasted for 20 years. Twenty-five years later, a second attempt was made to re-establish the bank, but President Andrew Jackson was opposed and put an end to it. The Fed, as we know it today, was started in 1907 and has been in charge of monetary policy for more than a century.

Its goal is to stimulate the economy in bad times and slow things down when inflation is increasing too fast. Inflation is when prices are going up too fast and consumers are losing too much purchasing power.

Most economists like to see an inflation rate of about 2 percent, a level that can be easily maintained and most people looking for work can find jobs. Hyperinflation is not good for the economy and, as we have seen in some Third World countries, is causing huge unrest among citizens.

Deflation when prices are going down is a major concern as well. If prices of automobiles and houses were falling rapidly, people would stop buying them because they believe those items will be cheaper in a year. That means we would start to see major layoffs in steel, auto industries and many others. A lot of people losing jobs could wreck the economy.

Fed members are nominated by the president and confirmed by the Senate. Jerome Powell is the current Fed president. Members usually hold eight meetings a year, and vote about things such as raising interest rates. The Fed had a nearly zero interest rate policy after the Great Recession in 2009.

Because the economy has improved, they have started to tighten monetary policy by implementing nine interest rate hikes of 0.25 percent.

The Fed’s action of dropping interest to near zero and employing Quantitative Easing, in which the Fed bought trillions of dollars of government bonds, gave birth to the current bull market that has taken the market to new heights. People were forced to take more risk in the stock market to get any return.

Because the market is the world’s biggest auction, all of the money flowing in made stocks go up. Also, low interest rates make price earnings ratios look better. Add the fact that many companies bought back huge amounts of their own shares and you have an unprecedented situation.

We had an inverted yield curve several weeks ago. This is when short-term bond yields are higher than long-term yields. In the past 50 years, this has happened every time there has been a recession. There has been only one false reading. This correction does not happen immediately, but it may be a concern.

People remember what happened to the stock market in October. The Fed raised interest rates for the fourth time in 2018, and said after the meeting it was going to get more aggressive in tightening the money supply in 2019. The market went down 20 percent.

Thank goodness we got a Santa Claus rally, which started Christmas Eve, that has restored most of the loss. The Fed is operating in new territory. Make sure that your market risk matches your risk tolerance and timeline.

Gary Boatman is a Monessen-based certified financial planner.

He is author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.