3. What Mistakes did the Federal Reserve Make in Managing the Stock Market Boom?
Alan Greenspan – then Federal Reserve Chairman – inflamed investments in the stock market by his tendency to favour expansionary monetary policy. Interest rates were slashed by 25 basis points on multiple occasions from mid-1990s due to economic downturns, which was a catalyst of the margin lending boost by 144% from 1997-2000.
Miller et al. noted that the Fed created a moral hazard problem which caused high technology stock valuations due to investors' faith that Greenspan, if necessary, would cut interest rates and inject cash in the economy to counter deflation, referred to as “Greenspan put”. Risk-taking in dot-com stocks prevailed as investors believed “Uncle Alan” would intervene when needed to correct market falls and mitigate asset losses.
Simplistic Speeches
Greenspan’s speeches during the dot-com era, which were coupled with vagueness and rhetorical questions, became commonly known as “Fed speak”. Greenspan’s infamous speech in 1996 of “irrational exuberance”, warning of overconfidence intensifying asset values, was criticised by many including Clowes for failing to adapt solid policies at an early stage such as raising the Fed’s margin requirements. Comparably, Hartcher argued that Greenspan was aware in the beginning of equity markets overheating but was ineffective in taking action.
Changing Course
Inflationary concerns triggered monetary tightening as the federal funds rate was raised six times from June 1999 to May 2000. This induced mass unemployment as Govetto and Walcher revealed that in 2000, for the first time since many years companies made more people redundant than new jobs were created. The unemployment rate rose by 1.6% between 2000-2001 and with lower income the technology bubble was pricked as investors' preference moved from speculative stocks to safer assets like bonds.
In conclusion, the Federal Reserve - the agency responsible for financial stability through regulating the stock market - mistakenly intensified the technology boom due to the inflationary and deflationary policies utilised as well as the inability to intervene earlier.
