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By Mark Germain
You might be wondering about the avian analogy. Doves and hawks once referred to politicians (and others) with anti-war and pro-war leanings, particularly during the Vietnam era. But what does this have to do with monetary policy?
To begin answering the question, we need to define the role of the Federal Reserve System, the central bank of the United States. The job of “the Fed” is to conduct the nation’s monetary policy by influencing money and credit conditions to promote full employment and stable prices.
How? Its main leverage tool is varying the rates regional Fed banks charge its member banks through its “discount window” (known as “the discount rate”). That rate, in turn, impacts the “fed funds rate” — the interest rate that banks charge each other for short-term loans.
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Any movement in the fed funds rate eventually trickles down to U.S. households and businesses in the interest rates charged by banks for short and long-term loans such as car loans, mortgages, commercial loans, as well as corporate bonds. The Fed can also try to influence longer-term interest rates by buying or selling U.S. securities (and, during the financial crisis, other debt instruments).
The more bonds the Fed buys (generally by creating new money), the greater the liquidity in the financial system, pushing interest rates down. In the reverse scenario, the Fed sells bonds (i.e. borrows money), pulling funds out of the system, creating competition for private borrowers, thereby forcing interest rates upward.
Currently, the fed funds rate is 0.50% and at historic lows since 2008. Pre-financial crisis, it tended to hover between 2% and 5%.
The last attempt by the Fed to normalize (i.e. raise) rates was nearly a year ago, back in December, 2015. The FOMC meets eight times per year to decide whether to try to change rates, or not. Not everyone agrees or thinks about monetary policy in quite the same way hence why we use the terms doves and hawks, as a way to personify their position on interest rates.
A dove is someone who wants to keep interest rates lower, in hopes of accelerating economic activity by a) making it cheaper for consumers and businesses to finance new purchases, and b) keep variable rate interest costs down for current borrowers, giving them extra cash to spend in other ways. The goal is to boost demand for labor, driving the unemployment rate downward.
This article was provided by our partners at ETFTrends.