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 stock 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 losses 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.