Strategic Fixed Income Investing: An Insider's Perspective on Bond Markets, Analysis, and Portfolio Management

CHAPTER 8

The Federal Reserve and Central Banks

Achieving price stability is not only important in itself, it is also central to attaining the Federal Reserve's other mandate objectives of maximum sustainable employment and moderate long-term interest rates.

—Ben Bernanke

The Federal Open Market Committee (FOMC) was established by the Banking Act of 1933 and is comprised of 12 members. Investors within the fixed income and equity markets know that the FOMC is responsible for setting monetary policy. Monetary policy is a term that gets thrown around many different ways.

The classic definition provided by the Federal Reserve is as follows:

The term “monetary policy” refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.

The FOMC is responsible for carrying a dual mandate on its shoulders. Many investors, including myself, feel that the committee is burdened with conflicting principles in that dual mandate. Responsibilities of the committee include the promotion of economic growth or maximum employment while holding inflation in check and keeping prices stable. As you can imagine, this balance is an ongoing tug-of-war; too much money in circulation contributes to inflationary pressures. Recent years have provided the committee a “get out of jail free card.” The free pass was the prolonged low headline inflation level. Because inflation remained out of the ...