The Stock Market Reacts to the Fed’s Interest Rate Hike

After the Fed’s November meeting, when the Fed decided not to hike interest rates, the stock market fell, indicating the disappointment of market participants. As I noted at the time, because lower interest rates tend to raise asset prices, the market decline was an indication of disapproval from market participants.

At the Fed’s December 16th meeting, in keeping with expectations, they announced they will increase interest rates for the first time in nearly a decade. After the announcement, the stock market surged.

While I am always reluctant to associate movements in the stock market with specific causes, this one looks pretty clear. The surge in the stock market came right after the announcement.

Following the conventional wisdom, higher interest rates should lower asset prices, so the rise in the stock market is all the more interesting. Investors appear to believe that the damage being done to the economy as a result of artificially low interest rates is greater than the boost to asset prices that come with low rates.

This appears to be clear evidence that the investment community believes that interest rates have been held too low for too long. The Fed kept interest rates low because of their belief that they could use monetary policy to engineer the economy toward a more rapid recovery, but manipulating the money supply is a form of central economic planning that distorts prices and interferes with rational economic calculation.

Am I right in my thought that excessively low interest rates were harming the economy rather than facilitating recovery? Investors in the stock market are casting their dollar votes that way.

Randall G. Holcombe is a Research Fellow at the Independent Institute, the DeVoe Moore Professor of Economics at Florida State University, and author of the Independent Institute book Liberty in Peril: Democracy and Power in American History.
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