The Fed Keeps Its Eye on Swings in the Stock Market

Janet Yellen may be leaning toward the idea that Wall Street can be an early economic indicator

“Animal spirits in financial markets wax and wane”

- Matthew Boseler

 

William Dudley, president of the Federal Reserve Bank of New York, has long believed that Fed policymakers should pay more attention to stock market swings. Now, with the Fed lifting rates for the first time in almost 10 years, Dudley, who also serves as vice chairman of the Fed’s Open Market Committee, has a chance to put his ideas into practice.

The Fed has a dual mission: to keep unemployment low and prices stable, which it tries to accomplish mainly by making changes in a key lending rate, the federal funds rate. To assess the economy, it examines data such as monthly reports on the job market and consumer spending. It doesn’t put a lot of weight on stock prices, which can be volatile, plunging and soaring from day to day, sometimes for no apparent reason.

Yet market swings can make investors feel poorer or richer, influencing their willingness to spend money. Because that may give an earlier signal on the direction of the economy than statistics such as consumer spending, Dudley thinks the Fed should factor what happens on Wall Street into its monetary policy deliberations. If it does—and with the stock market up more than 10 percent since Donald Trump’s election—the Fed could raise interest rates higher, or more quickly, this year than other statistics might indicate.

“Animal spirits in financial markets wax and wane, pushing asset values up or down in a manner that can more than offset the effects of movements in short-term interest rates,” Dudley said in a speech titled The Importance of Financial Conditions in the Conduct of Monetary Policy on March 30. “The movements in many financial markets following last year’s presidential election are a notable example of this phenomenon.”