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Love 'em or Hate 'em, Why You May Be Wrong About the Fed

| MoneyRates.com Senior Financial Analyst, CFA
min read

percent-sign-on-us-dollarOn the one hand, the Federal Reserve's monetary-policy decisions are scrutinized by the media and Wall Street with a level of attention befitting an ancient oracle about to make a life-or-death pronouncement. At the same time, politicians and others freely berate the Fed as being clueless, out of touch, or up to no good.

When people both overrate and underestimate the Fed, it might be that something else is driving the perception because, in reality, the Fed is neither as all-powerful as some people seem to think nor as capricious as others accuse it of being. What could account for such dramatically different viewpoints?

Common misconceptions about the Fed

In this case, it could be that certain misconceptions about the Fed exist that allow differing opinions to develop. Nonetheless, it's unfortunate when popular notions are perpetuated if they're incorrect - particularly if they lead people to make poor financial decisions. So here are four points that might help clear up some of the misconceptions people may have about the Federal Reserve Board:

Misconception #1 - The Fed Chair acts alone

First of all, the Federal Reserve is a massive organization with duties that go well beyond setting interest rates, such as, working on financial regulations and managing the money supply. However, the function of setting interest rates is generally what draws the most attention.

It's true that whoever happens to be the Federal Reserve Chairperson tends to be a lightning rod for politicians, investors or commentators who might not like the latest interest-rate decision, but the Fed Chair does not act unilaterally. Interest-rate decisions are made by the Federal Open Market Committee (FOMC), a committee of several Fed officials that includes the Chair. There are currently ten FOMC members. All of these officials vote on policy decisions so, while the Chair - currently Jerome Powell - has considerable influence, he (or she) does not have the ultimate control over those decisions.

As a noteworthy example of how people tend to overstate the Fed Chair's role, in December of 2018 the Fed made a controversial decision to raise interest rates at a time when the stock market was struggling. There was even a fair amount of speculation about whether the President should fire Powell. However, that December 2018 decision was a unanimous choice by all ten members of the FOMC. It is unlikely that changing the Fed Chair would have changed the overwhelming conclusion of the group.

Misconception #2 - The Fed's job is to keep the party going

Many people see the Fed's actions as appeasing Wall Street, which would generally involve keeping interest rates low - but this is not part of the FOMC's job description. The FOMC's stated objective is to strike a balance between encouraging employment and controlling inflation.

While the Fed was criticized recently for not being sensitive to a weakening stock market, in contrast it was criticized for not doing more to rein in Wall Street speculation after the dot-com bubble collapsed. Beyond some remarks by then-Chair Alan Greenspan about "irrational exuberance," the Fed did nothing to check rising Wall Street speculation. Trying to manage employment and inflation is enough of a challenge; the Fed cannot also be expected to save investors from themselves.

Misconception #3 - The Fed controls most consumer interest rates

When the Fed raises interest rates, you usually see several stories in the media about how consumers are likely to see higher rates on mortgages and other banking products. However, the only rates the Fed controls are very short-term rates at which banks borrow money.

While this may have some influence on consumer rates, the fact is that rates on everything from mortgages to savings accounts often move up and down independently, even when the Fed has not changed its federal-funds-rate target. Consumer rates are influenced by the same things that influence the Fed's rate decisions - job growth and employment. With hundreds of financial institutions making decisions about consumer rates in a competitive market, rates often do not wait for a Fed meeting or interest-rate decision before moving in reaction to economic conditions.

Misconception #4 - The Fed operates within a shroud of mystery

There is a man-behind-the-curtain view of Fed decisions that probably stems from the overdone media mystique about the Fed Chair. But in fact, the Fed tries very hard not to surprise the public because surprises are disruptive to financial markets and business-decision makers.

The Federal Reserve website is full of detailed policy statements, speeches and other materials explaining how the Fed views monetary policy in the context of current economic conditions. The FOMC even releases year-by-year projections of where it thinks its interest rates will go over the next few years. The Fed's forecasts are subject to change as conditions evolve; but to the extent it can foresee where rates are going, the Fed makes every effort to help anyone who is interested look in the right direction.

What really drives the Fed's decisions

The Fed's impact on monetary policy can be greatest at times of financial crisis such as in the Great Recession and its aftermath. Most of the time, though, the Fed is trying to maintain the economy's course rather than steer it in a radically new direction. The Fed's statements and decisions are primarily important for what they say about employment and inflation because those two economic forces drive not just Fed policy but also the financial circumstances of individuals and businesses.

Understanding what really drives Federal Reserve Board decisions can help consumers base their financial decisions on more than public sentiment and media mystique.

Learn more about the Federal Reserve Board:

Latest FOMC meeting recap

How accurate is the Fed? Read Reality check: Evaluating the Federal Reserve Board

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