January 05, 2012
Is the Fed ruining your Retirement?
For the past century, a politically independent central bank has proven, at worst, “the least bad thing” for long-term economic stability. A reading of monetary policy history, in particular Friedman’s work, gives an appreciation for both why and how it works. We can thank the Fed for keeping borrowing rates predictable. The low volatility leads to lower rates, as the imbedded option prices are lowered. The lower rates then keep inflation at bay, even as the Fed pumps up the money supply like a weather balloon, right? And low inflation keeps the stock market and broader economy from a downward spiral, right? That’s the traditional argument, anyhow.
But this is where a pair of economic findings in the last few days step in. The first link started the discussion a couple of days ago, showing the link between inflation and the stock market since the beginning of 2008 (i.e. during the Recession). The second link, from a blog posting this morning, broadened the study to the beginning of 2003, thus showing a nearly full economic cycle, including the build-up, then bursting, of the housing bubble.
First study, by Eddy Elfenbein.
Second study, by David Merkel.
The key finding, that there is a very high correlation between expected inflation rates and stock market performance, is not trivial. If this relationship is causal, and not just correlated, it leads to a legitimate policy discussion of whether the Fed’s inflation-fighting policy is holding down the stock market’s recovery. Those hoping to retire soon might have a problem with that!
Think of it this way: What if the pressure to keep inflation low has actually prevented the stock market from rebounding? If so, the inflation fighting has constituted a gigantic transfer of wealth from business owners (who forego higher net worth from rising stock prices) to the middle and lower class (who benefit from lower day-to-day prices of goods and services). And for an individual delaying retirement, after seeing a decade of savings going up in smoke due to stock market losses, it begs the question of whether the Fed, with its inflation-fighting, has impacted your retirement.
Who knew technical graphs could get so personal.
