Will there be a “Powell put” now that Jerome Powell has taken charge as chairman of the Federal Reserve?
To be sure, recent gyrations in stocks prices are not sufficient for the central bank to change the policy path just yet. More interest-rate hikes are coming. But the return of volatility raises awareness that markets can shift quickly. Will the Fed be there to keep market turmoil contained? Probably yes, but there is a risk central bankers will be slow to respond to a market downdraft that threatens the economy.
Shortly after the market crash of 1987, the Fed cut rates, changing course in the middle of a tightening cycle. That action has famously become known as the “Greenspan put” because of the implied promise that central bankers led by Fed Chairman Alan Greenspan would bail out market participants who indulged in risky behavior.
Subsequent similar actions by the Fed have reinforced beliefs that it continues to use the Greenspan put. The Fed cut rates in the wake of stock market losses during the Asian Financial Crisis. It began its program of quantitative easing in response to the global financial crisis. More recently, the much-anticipated campaign to normalize rates was expected to begin in September 2015, but that hike was delayed until December after a tumultuous summer on Wall Street.
The Fed’s response has been criticized. A common complaint is that the Fed now encourages moral hazard, or the taking of excessive risk. There have even been rumblings that the White House intends to appoint Fed governors sympathetic to ending the Greenspan put.
But would any Fed really bring an end to the Greenspan put? A couple of points to remember. First, for all the claims that the Fed is always there to bail out investors, the truth is very different. Asset prices fell sharply in 2000-2001 and 2007-2009. Fed rate cuts clearly were insufficient to make investors whole in those cases. So there really isn’t a Greenspan put that can keep investors from suffering loses in all cases. Second, it is the Fed’s role to offset shocks that threaten to harm the economy. If the central bank were to ignore deteriorating financial conditions, it wouldn’t be doing its job.
Ultimately, Powell, who took office Feb. 5, would follow his predecessors and continue to respond to market conditions with appropriate adjustments to monetary policy. Neither monetary officials nor fiscal authorities can allow financial markets to collapse while they fret about moral hazard. Remember what happened when the Fed let Lehman Brothers fail? Or when Congress failed to pass the Troubled Asset Relief Program? It wasn’t pretty.
Still, there can be a delay between when action is needed and when it actually occurs. This is the risk associated with loading the Fed with governors with an ideological opposition to the Greenspan put. The longer the delay, the more downside the economy faces. And most likely, the more subsequent action would be required to stabilize the economy, and a longer period of recovery. It’s fine to stay focused on the economic forecast and not respond to turmoil of last week’s magnitude. It’s not fine to let events of the magnitude of the Asian Financial Crisis, for example, fester.
Although many complain about the Greenspan put, I don’t see a reality that doesn’t include it. At least not one that is acceptable to policy makers. Powell would be wise to keep the Greenspan put in the Fed’s tool kit.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tim Duy is a professor of practice and senior director of the Oregon Economic Forum at the University of Oregon and the author of Tim Duy's Fed Watch.
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