Recession and Equity Markets

Recent fears of a recession have brought down the equity markets (NYSE and NASDAQ) to lower lows than expected. Simply defined a Recession is a decline in economic activity within an economy, usually characterized by higher unemployment and less investment in new plants and equipment. As of now we are not experiencing a recession although the economy of the United States has slowed down considerably. This slow down has been caused, mainly, by the fiscal policies adopted by the Federal Reserve.

At the height of the 2000 bull market (around April) the Federal Reserve, popularly known as the Fed, believed that the economy was growing too rapidly. An economy that grows too fast may bring about inflation, an unwanted reaction. To prevent inflation, the Fed wanted to raise rates and thereby slowing down the economy. Raising interest rates causes the money supply available to the US Financial system to decrease. This, for various reasons, causes the economy to slow down.

After raising interest rates six times in 2000, it seems the Fed may have overplayed their hand. Federal Reserve Chairman Alan Greenspan has recently said that the US economy may begin to stagnate, in other words the growth will be minimal to none. To counteract this, the Fed eased interest rates early this year and it seems they will do so again. In addition, Alan Greenspan has supported the proposed tax cut by President Bush. Some economists argue though that by the time the tax cut passes through congress, the easing of interest rates will have helped the economy already.  This goes to show that economics is an inexact science.

This is just a summary of the major economic issues plaguing the stock market this year. Keeping an eye on the Fed and on the proposed tax cut should be a priority of every investor. Even if one does not understand the intricacies of fiscal policy, one should try to follow developments in the area.