Challenging the Notion that the Fed will Support Markets to Prevent a Crisis
A pervasive belief throughout both the mainstream and independent media is that when faced with the threat of an economic downturn, central banks will act unconditionally to lower interest rates and inject fresh stimulus into markets by way of quantitative easing. One theory is that they will do this to stave off a collapse of the economy amidst rising trade ‘protectionism‘. But is the idea of central banks enacting policy to avert economic disaster one that stands up to scrutiny?
To gain a broader understanding of how banks behave before and after a financial crisis is triggered, the historical actions of the Federal Reserve are a good place to start.
The Great Depression
In a 2013 article written by Gary Richardson of the Federal Reserve Bank of Richmond, Richardson candidly explains how in 1928 and 1929 – leading into an impending stock market crash – the Fed were raising interest rates. According to Richardson, they did this ‘in an attempt to limit speculation in securities markets‘.
Conditions at the time included an influx of borrowed money being poured into the stock market, which contributed heavily to the soaring price of shares. A month before the crash that eventually manifested into a depression, the Dow Jones stood at a record high of 381 points.
Today, the Dow Jones is approaching an all time high of 27,000, and since it’s post crisis low of 6,469 has increased by 317%. A combination of ultra accommodative monetary policy and corporate stock buybacks has been responsible for much of this rise.
There were two significant ramifications from the Fed’s decisions to raise rates prior to the Great Depression. The first was that economic activity in the U.S. began to slow and, to quote Richardson, ‘because the international gold standard linked interest rates and monetary policies among participating nations, the Fed’s actions triggered recessions in nations around the globe.’
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