Doves and hawks
This series gives you insights into the monetary policy stance of each of the dovish FOMC members. Let’s start by understanding the structure of the FOMC and what it is that differentiates doves and hawks.
Monetary policy and the Federal Reserve
“Monetary policy” refers to the actions taken by a nation’s central bank to influence the availability and cost of money and credit in order to help promote national economic goals. In the U.S., the Federal Reserve (or Fed) is responsible for achieving national economic goals through monetary policy under the Federal Reserve Act of 1913.
To achieve its goals, the Fed can use three monetary policy tools.
- Open market operations
- The discount rate
- Reserve requirements
The Federal Open Market Committee (or FOMC) is responsible for open market operations, while the Board of Governors of the Federal Reserve System is responsible for setting the appropriate discount rate and reserve requirements. These tools help the Fed influence the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the Federal funds rate.
The Federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. Changes in the Fed funds rate reflect in the performance of ETFs tracking Treasury securities like the iShares Barclays 1–3 Year Treasury Bond Fund (SHY) and the iShares Barclays 20 Year Treasury Bond Fund (TLT). However, with interest rates being low for a while and the market expecting a rise, investors sometimes prefer ETFs designed to play rising interest rates, such as the SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN), which tracks the floating-rate debt of companies like Goldman Sachs (GS) and JP Morgan Chase & Co. (JPM).
The Federal Open Market Committee (FOMC) consists of twelve members:
- The president of the Federal Reserve Bank of New York
- The seven members of the Board of Governors of the Federal Reserve System
- Four other Reserve Bank presidents on a rotational basis
The FOMC holds eight regularly scheduled meetings per year. At these meetings, the committee reviews economic and financial conditions, assesses the risks to its long-run goals of price stability and sustainable economic growth, and determines the appropriate monetary policy stance.
At each of these meetings, members of the committee express their views on the state of the economy along with their stance on monetary policy actions. The difference in these views is what differentiates a dove from a hawk in the FOMC, as we’ll discuss more in the next part of this series.