Unlocking the secrets of the Fed: how monetary policy affects the economy and your wealth-creation potential

273 Pages·2002·3.06 MB·English

by  David M. Jones

Unlocking the Secrets of
the fed
How Monetary Policy Affects the
Economy and Your Wealth-Creation
Potential
DAVID M. JONES
John Wiley & Sons, Inc.
Frontmatter Page vi Tuesday, July 2, 2002 1:55 PM
Frontmatter Page i Tuesday, July 2, 2002 1:55 PM
Unlocking the Secrets of
the fed
Frontmatter Page ii Tuesday, July 2, 2002 1:55 PM
THE FRANK J. FABOZZI SERIES
Fixed Income Securities, Second Edition by Frank J. Fabozzi
Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L.
Grant and James A. Abate
Handbook of Global Fixed Income Calculations by Dragomir Krgin
Managing a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. Fabozzi
Real Options and Option-Embedded Securities by William T. Moore
Capital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. Fabozzi
The Exchange-Traded Funds Manual by Gary L. Gastineau
Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited
by Frank J. Fabozzi
Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and
Efstathia Pilarinu
Handbook of Alternative Assets by Mark J. P. Anson
The Exchange-Traded Funds Manual by Gary L. Gastineau
The Handbook of Financial Instruments edited by Frank J. Fabozzi
The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and
Moorad Choudhry
Frontmatter Page iii Tuesday, July 2, 2002 1:55 PM
Unlocking the Secrets of
the fed
How Monetary Policy Affects the
Economy and Your Wealth-Creation
Potential
DAVID M. JONES
John Wiley & Sons, Inc.
Frontmatter Page iv Tuesday, July 2, 2002 1:55 PM
This book is dedicated to my blessed grandchildren:
Caitlin, Dylan, and Josh, who are profound sources of joy,
pride, faith, love, and unbounded optimism.
Copyright © 2002 by David M. Jones. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
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ISBN: 0-471-22095-7
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
contents
Preface vii
Acknowledgements xv
About the Author xvii
CHAPTER 1
Celebrity Status—A Mixed Blessing 1
CHAPTER 2
New Challenges 19
CHAPTER 3
Potential Growth and Seven Rules for Central Bankers 51
CHAPTER 4
Major Concerns 67
CHAPTER 5
Monetary Policy Process and Indicators 95
CHAPTER 6
Asset Price Bubbles—Beware 167
CHAPTER 7
Top-Rated Contemporary Fed Leaders 183
CHAPTER 8
Terrorist Turmoil 199
CHAPTER 9
Conclusions 217
BIBLIOGRAPHY 229
INDEX 235
v

preface
As one of the pioneers of “Fed Watching,” I have an eternal
affinity for the mystery and power of central banking. In
the past, a veil of secrecy has shrouded central bank delibera-
tions and policy intentions. In contrast, the watchword today
is transparency regarding goals and tactics. In my 33 years of
closely observing our Federal Reserve (the “Fed”) from the
outside (preceded by five years as an economist at the New
York Fed on the inside), I have never seen central banking
more in the spotlight than at this moment.
This book is aimed at helping finance professionals—
including portfolio managers and bank and nonbank asset-
liability decision-makers—along with conscientious individ-
ual investors gain insight into the Fed’s behavior, with a view
to forecasting future monetary policy actions and related
movements in interest rates and the stock market. I will
examine closely the Fed’s policy objectives, operating tech-
niques, and favorite financial and economic indicators. Also,
I will thoroughly review the modern-day Fed’s main chal-
lenges and concerns in order to gain greater insight into its
policy actions.
Contributing to higher central bank visibility, in addition
to a deliberate Greenspan Fed effort at greater transparency,
has been the founding of the European Central Bank (ECB)
and the launching of the euro, scheduled to be fully phased in
as a single currency originally for 11 (now 12) major Euro-
pean countries by 2002. Also, there was the much-publicized
need for central bank cooperation in coping with the 1998
global financial crisis and, of course, in dealing with the fall-
vii
viii
Preface
out from the stunning September 11, 2001, terrorist attacks
on the United States.
The major function of a central bank is to serve as the
bankers’ bank; basically, the central bank is our economy’s
lender of last resort. Importantly, the Fed is the only govern-
ment agency that can create new money out of thin air
through the purchase of Government securities or other
assets. The Fed must, however, maintain sufficient monetary
discipline to achieve its primary dual objectives of stable
prices and sustainable economic growth. The central bank
must also maintain the integrity of the payments system,
assuring, for instance, that the arrangements for the settle-
ment of payments are efficient and secure, and most impor-
tantly, seeing to it that checks written in dollars on any bank
would be honored at par (full value) at any other bank in the
United States.
Secondarily, a central bank may also serve in a supervi-
sory capacity, overseeing banks or other financial institu-
tions. Under the terms of the Gramm-Leach-Bliley Act of
1999, for instance, the Fed enhanced its supervisory powers
by becoming “umbrella supervisor” of financial holding com-
panies that will own the nation’s largest banks, securities
houses, and insurance companies. Within the financial hold-
ing company structure, individual subsidiaries will also be
regulated according to their respective functions by the rele-
vant government agencies. Specifically, securities subsidiaries
will be regulated by the Securities and Exchange Commission
(SEC), banks by the Office of the Comptroller of the Cur-
rency (OCC) or State banking departments (depending on
whether they obtain a national or State charter), and insur-
ance companies by State insurance commissioners.
Most significantly, there is the remarkable celebrity of Fed-
eral Reserve Chairman Alan Greenspan, who, at least until
recently, has been more revered than any other central bank
head. The Fed Chairman heads, by common acclaim, the lead-
ing economic policy institution in the world; it is in effect the