FRAT, the Fed, and the Stock Market

Uncategorized

Why does the stock market rise or fall? The prospects of individual firms included in the Dow, the S&P 500, and other indexes move on their own, but up and down swings in an entire index are usually based on broader perceptions about the economy. If reports suggest that people expect a stronger economy, you would expect these indexes to rise. The Fed often inverts this expectation, however, making it more difficult and risky for investors.

For example, if an economic report suggests that businesses expect a more robust economy, markets may actually fall because investors worry that this will bring about inflation and a tighter Fed policy. In contrast, if an economic report suggests weakness, markets can rise because investors anticipate looser Fed policy. Hence, producers in our economy and the investors who provide them with needed capital are often less interested in legitimate market news and more interested in how the Fed will respond to it. Stocks and other securities are only partially market-based, leading to all sorts of misperceptions about how they should be priced and resulting in stock market volatility.

In an efficient market economy, private investment is channelled to the most capable firms, and business and investment decisions are based on market factors. Basing decisions on guesses about government or Fed policy disrupts this process and misallocates these resources. Firms best positioned to deal with government regulations or changes in Fed policy–not necessarily those best able to produce what consumers want–get more resources when this occurs. In this way, central planners in Washington are indirectly picking winners and losers. Ultimately, this hampers the ability of our firms to compete globally, expand their operations, and hire more workers.

Measures designed to limit Washington’s control of our economy are essential if it to be strong over the long term. FRAT is a move in the right direction.

2 Comments

2 Comments

  1. Gary F  •  Aug 10, 2014 @7:35 PM

    Last week Obama said the companies shouldn’t complain because stocks have been rising in his administration, but stocks often rise when the economy is bad because the Fed cuts rates or injects liquidity. Change in the DJIA doesn’t reflect the health of the economy.

  2. jackie  •  Aug 12, 2014 @9:06 PM

    it’s all about class warfare