Should the Fed intervene in the markets?

Should the Fed intervene in the markets? Yes and no.

Let’s start with no. Today’s Bloomberg has its piece Mohamed El-Erian with the following title and subheading:

The Fed Should Resist Market Capturing
The central bank needs to avoid running into another policy mistake by making an emergency interest rate cut.

The Financial Times has a similar piece Barry Eichengreen:

The Federal Reserve will not let the markets decide on a rate cut

Stock movements are not a reliable signal of an impending recession

I strongly agree with both commentators. The Fed shouldn’t be in the business of trying to prevent big moves in the stock market, and yesterday’s 3% drop in the S&P500 wasn’t even a very big move. (Yes, it was a lot bigger than the average, but I’ve seen a lot of bigger moves. As I write this, the S&P500 is up more than 2%.)

So why do I say “yes and no” at the beginning of this post? I guess it depends on what one means by “put markets.” Assume that there was a market for NGDP futures. If so, I would strongly support the Fed adopting a monetary policy that sets the market for NGDP futures.

Of course we don’t have a NGDP futures market. But we have many markets that indirectly provide information on market expectations of NGDP growth. Start with the fact that NGDP growth is the sum of inflation and real GDP growth. And then note that we have market indicators (admittedly imperfect) of expected inflation. In addition, there are many market indicators that are highly correlated with actual and expected average growth. Yesterday I remember a market analyst saying that the spread risk in the bond market has increased. Spread risk is associated with NGDP growth, as borrowers have greater difficulty repaying debt when NGDP growth declines significantly.

Suppose the Fed built a model to estimate market expectations of NGDP growth, using a weighted average of all relevant market prices. It might make sense to try to stop that index, without trying to stop any one part of that index. Would that be “marketing”? I think that’s kind of a word question. The Fed will not have market stability as a primary goal; rather they will be trying to stabilize markets in such a way that doing so will stabilize NGDP growth. As a matter of fact, they may occasionally respond to severe movements in the stock or bond markets, but not because they care about the plight of investors.