Economic factors and business cycles
**The Federal Reserve** conducts monetary policy through three primary tools: • **Open market operations** — buying/selling Treasuries to adjust reserves and the federal funds rate. • **Discount rate** — rate at which banks borrow directly from the Fed (now split into primary credit, secondary credit, seasonal). • **Reserve requirements** — the ratio of deposits banks must hold as reserves. Set to 0% in March 2020 and remains there.
**Loose (accommodative)** monetary policy — low rates, Fed buying securities — tends to raise bond prices, weaken the dollar, and support equity valuations. **Tight (restrictive)** — rate hikes, QT — does the opposite.
**Fiscal policy** is set by Congress via taxation and spending. Running a deficit (spending > revenue) expands aggregate demand; surpluses contract it.
**Business cycle phases:** expansion → peak → contraction → trough. Indicators: • **Leading** — stock prices, PMI new orders, building permits, yield curve (inverted curve historically precedes recession 12-18 months). • **Coincident** — GDP, industrial production, employment. • **Lagging** — unemployment, CPI, prime rate, C&I loans.
**Inflation measures:** CPI (consumer basket), PPI (producer), PCE (Fed's preferred). The Fed targets 2% PCE inflation.
**Yield curve shape:** • **Normal** — upward-sloping (longer maturities yield more). • **Flat** — little spread across maturities, often precedes inversion. • **Inverted** — short rates > long rates; reliable recession signal historically (1978, 1989, 2000, 2006, 2019, 2022). • **Humped** — mid-maturities highest.
**International factors:** balance of payments, exchange rates, capital flows, sovereign ratings.