Greenspan is stepping down Tuesday after 18 years as chairman of the Federal Reserve, one of the most powerful agencies of the federal government because it controls, among other things, the nation’s money supply and interest rates.
One of Greenspan’s last public duties will be to preside over the Fed’s Open Market Committee (FOMC) meeting on Tuesday. It is widely expected the panel will raise short-term rates another quarter point to 4.5 percent.
This will bring short-term rates to their highest in almost five years.
What Does it Mean?
What does any of this have to do with the stock market?Interest rates are the accelerator for the economy in many ways. If interest rates are low, businesses and consumers are encouraged to borrow. Businesses expand and consumers buy homes, cars and other big-ticket items.
When interest rates rise, it tends to slow the economy. Businesses are reluctant to take on more debt and consumers may find it harder to qualify for a loan. The job market may tighten and nervous consumers cut back on spending.
One of the Fed’s main challenges – and many would say the absolute most important one – is controlling inflation.
Greenspan has made a reputation as an inflation fighter who takes a hard-line approach. His weapon of choice is interest rates.
Too Fast
If the economy begins growing too fast because of cheap money (low interest rates), there is a danger that inflation may become a problem.Inflation occurs when there is more money than goods or services, which drives up prices and devalues the currency. Your dollar won’t buy as much.
The danger of raising interest rates to fight inflation is that if rates are raised too high or stay high for too long, it can slow the economy down too much. In a radical situation, this could result in a recession.
Over the years, Greenspan has handled this balance as well as any of his predecessors by most accounts, although no person occupying the post of Fed chairman will please everyone.
Replacement
Greenspan’s replacement is Ben Bernanke, who observers believe is a capable inflation fighter in his own right. He will, however, have some big shoes to fill. Greenspan has been a fixture in Washington and reappointed to his post by both Democratic and Republican presidents.
The stock markets expect an interest rate hike Tuesday and know Greenspan is leaving. What Fed watchers will be looking for in the coming weeks are hints from Bernanke about his plans for future rate hikes.
