The Federal Reserve's about-turn in monetary policy in January, after the equity market swoon in the fourth quarter, showed that even Jerome "Straight-Talking" Powell joined his predecessors Alan "Irrational Exuberance" Greenspan, Ben "Taper Tantrum" Bernanke, and Janet Yellen in falling prey to the wiles of the equity market. The Fed should give up the pretense that it is focused on just unemployment and inflation and publicly acknowledge that the equity market matters. Heck, it should go one step further and make the lives of many pension funds much easier by explicitly stating that it is targeting a rate of return. It would clean up a lot of the chaos, mistakes and inefficiencies in managing pension funds. The fact that defined benefit plans were overfunded in the late 1990s and are now well below full funding is evidence of the havoc monetary policy has had on retirement security.
Professor Robert C. Merton and I argued that traditional monetary policy, by trying to increase absolute wealth (i.e., "boosting the stock market") of investors through lower interest rates did great damage to retirees and pension funds. In short, by lowering interest rates, the Fed raised the value of retirement liabilities of both DB plans and DC accounts by more than they raised the value of assets, thereby making pension portfolios worse off because the funded status, or "relative wealth," declined. This move, in turn, caused these funds to have to "save more" through additional contributions, taking precious resources away from consumption (of individuals saving in defined contribution plans), investment (of companies sponsoring defined benefit plans) and government spending (from government entities sponsoring pension plans). By backing off interest rate increases in 2019, and even potentially lowering them by 50 basis points this year, it runs the risk of exacerbating its original sin and further worsening relative wealth in DB and DC plans.