It’s been said for years that the most powerful man in the world is not the president of the United States, the British prime minister, or the Communist Party boss in the People’s Republic of China.
We’ll have to amend the question to ask, who is the most powerful person when it comes to influencing the world’s economy?
The answer, of course, is the new head of the Federal Reserve’s board of governors, Janet Yellen. Ever since she was nominated, the question has been whether Ms. Yellen is a hawk or a dove when it comes to interest rates.
The term “hawk” describes a Fed head who is more concerned with inflation than the short-term growth of the economy, while a “dove” does not want to risk the higher unemployment that usually comes with rising rates.
There’s a popular misconception that the Fed raises or lowers the prime rate. It doesn’t; its primary weapon is the discount rate, which is the rate that banks pay to borrow from the Fed. Even though the amount of borrowing is a small measure when it comes to the overall economy, it is the influence it has on the federal funds rate. The federal funds rate is the rate set by banks to borrow from one another on what are known as “overnight” loans.
If you’re wondering why you don’t hear, or read about what the Federal Reserve is doing, it’s because rates have been held steady for more than five years. That means tolerable mortgage rates, commercial loan rates and personal loan rates – for the most creditworthy borrowers. The main reason the Fed hasn’t intervened to raise rates, which would slow the economy, is that we’ve had very little inflation. If you’re old enough, you might recall the economic pain and suffering under presidents Ford and Carter, Republicans and Democrats alike.
You might wonder if the soaring inflation and interest rates back in the 1970s and early ’80s can be blamed on either party. I would say “no”; the blame would lie at the feet of OPEC, the Organization of Petroleum Exporting Countries. It was not enough that in 1973 the price of a barrel of oil went from $3 a barrel to $10; in 1979 the price soared from $10 or $15 to $40. That $40 figure, which would be considered very low right now, caused the prices of, well, virtually everything, to rise at the frightening rate of somewhere between 14 percent and 20 percent.
I guess I’m making a short story long, to reverse the old adage, but the inflation of 35 years ago still drives the interest rate decisions made by the Federal Reserve. Now we are playing the guessing game: what will Chairwoman Janet Yellen do?
Bud Stevenson, a retired stockbroker, lives in Fairfield. Reach him at [email protected]