Feds & Stock Market

Feds and the Stock Market

In the past, the Federal Reserve has used the purchase and sales of bonds to stabilize the money supply. This is because bonds are a no loss resolution to the stabilization process. The sales and purchase of bonds have a definite return and this is why it is the best solution. Although there are other tools available for this process, most of these tools do not have the stability and the definite return that a bond produces.

Open market operations are the main source that the Federal Reserve utilizes in order to control the money supply. This means that they increase or decrease the money supply through sales or purchase of government bonds. The Fed is constantly buying and selling Federal Bonds in order to influence the level of reserves in the banking system. Nevertheless, they do not purchase these from the government directly. These purchases are made through security dealers who compete in the market. This is where the term open market comes from.

If the Federal Reserve conducted monetary policy through the purchase and sale of stocks on the New York Stock Exchange, it would greatly affect the public sector. Technically the Federal Reserve could use the stock market if it wished to. They could purchase stock in order to increase the money supply and then sell stock in order to decrease it. There are problems with the Fed doing so though. First would be the fact that the Fed would invest such a large amount of money that it would increase the price of stocks by a huge amount. By doing this, they are making the sale of stocks to individuals nearly impossible.

The Fed has control of such a large amount of money that this would cause the Fed to own a large share of stocks that are available and would make the prices rise substantially. The problem is that the stock exchange is not a constant should the Fed invest in the stock market. In other words, the prices and value of stocks rise and fall too easily for this to be considered an avenue to controlling money supply. This is due largely to the fact that, unlike bonds, stocks do not have a definite value. In other words, when you invest in stocks, you are playing the market, as you would a board game. You never know what the value of the stock will be from one day to the next. So therefore, with investment, you take a large risk of losing some or all of the money invested. This is why the Fed invests in bonds and