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Wall Street’s winged icons: How hawks and doves shape the economy

Hawks remove the punch bowl; doves spike the punch.

Written byKarl Montevirgen

Fact-checked byDoug Ashburn

Composite image of a hawk and a dove in flight.

Who’s flying the financial skies?

Bulls and bears may be the classic icons on Wall Street, but circling above the broader landscape are two avians whose economic powers may be far greater: Hawks and doves.

In finance-speak, “hawkish” and “dovish” represent two distinct approaches to fiscal and monetary policy. The most impactful of the two domains arguably belongs to the monetary realm, where the Federal Reserve’s policies—namely the Fed funds rate and its balance sheet operations—play a significant role in shaping the economy and, more immediately, market sentiment and response.

Key Points

Monetary hawks favor “tighter” monetary conditions to prevent runaway inflation.
Monetary doves favor “easy money” policies to boost economic growth.
Federal Reserve officials range within the hawkish-to-dovish spectrum; economic realities require a balanced and fine-tuned approach.

What’s the difference between a (monetary) hawk and a dove?

The simple answer:

Monetary hawks favor “tighter” monetary conditions to prevent runaway inflation. Paul Volcker, who pushed the Fed funds rate to 22% to combat the stagflation of the 1970s and early 1980s, was the quintessential hawk.
Monetary doves favor “easy money” policies to boost economic growth. Ben Bernanke, who was Fed chair during and after the 2007–08 financial crisis, earned the nickname “Helicopter Ben” for his dovish approach to combating the post-crisis deflationary environment. (“Helicopter money” is a euphemism for dovish monetary policy, as in “throwing money from a helicopter” to keep the economy moving.)

To some degree, hawkishness and dovishness describe the propensities of individuals, but sometimes, economic realities force a hawk to be dovish and vice versa.

Monetary hawks are considered the eyes and ears of inflationary pressure

Hawkish monetary policy is typically characterized by efforts to keep inflation at bay. For example:

Hiking interest rates when the economy shows signs of overheating. When the cost of borrowing is expensive (e.g., high interest rates for mortgages, auto loans, and for companies looking to expand), people tend to borrow and spend less. This helps decrease the demand for goods and services. Over time, this tends to ease inflationary pressures by slowing down price increases or (indirectly) lowering prices.
Tightening the money supply. If inflation can be defined as “too much money chasing too few goods,” then reducing the amount of money circulating in the economy removes a critical part of that equation.

The downside to all this is that a tighter monetary policy can also choke economic growth (even if, as some would argue, that growth is “artificially” generated). Hawks argue that inflation will only erode a currency’s purchasing power. So, even if economic growth means more jobs and higher wages, your money will buy less because it’s worth less.

Monetary doves are seen as economic growth cultivators

On the other end of the spectrum, monetary dovish policy favors “easy money” policies to boost the economy. What does easy money look like?

Lower interest rates. When the cost of borrowing money is cheap, it encourages consumers and businesses to spend, take out loans, and invest—all of which can boost the economy.
Increasing the money supply. When the Fed lowers the fed funds rate, it encourages banks to issue more loans. When banks issue loans (often a fraction of their deposit reserves), they “create” more money flowing into the economy. And when the Fed purchases government Treasurys and other securities to keep interest rates low—what’s popularly known as quantitative easing (QE)—it also “creates” money to make those purchases.

Doves tend to be more tolerant of inflation, especially when the economy needs boosting (like during a recession). In their view, inflation is a risk worth taking when facing high unemployment and economic stagnation or decline.

Ideally, economic inflation shouldn’t be too hot or too cold.

Encyclopædia Britannica, Inc.

It’s a delicate balancing act

There are financial media websites that rank Federal Reserve officials’ levels of hawkishness and dovishness, as each official’s policy stance tends to be consistent within a certain part of the hawk/dove spectrum.

But it’s not that simple. The Fed’s “flexible” stance requires consensus among its members. So, again, although each official may lean more toward the hawkish or dovish side, their policy positions often change to accommodate the economy’s needs. Ultimately, their collective decision may be more hawkish or dovish depending on the circumstances (see figure 1).

Chart of Fed funds rate vs U.S. consumer price index (CPI)

The Fed will raise or lower the Fed funds rate (blue line) to strike a not-too-hot, not-too-cold balance between keeping inflation measures such as the Consumer Price Index (red line) in check while blunting the effects of economic slowdowns (shaded areas).

Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [DFF]; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank

How does the stock market respond to hawkish and dovish monetary policy?

A hawkish central bank move is like that of a music DJ who, midsong and with very little warning, switches from a hyped-up dance track to an ultra-chill jam while everyone’s still dancing. Plus, the proverbial punch bowl that made everyone “happy” is taken away.

If you can imagine how the partygoers might feel, then you can imagine Wall Street’s response to word of an interest rate hike. As decreased spending and borrowing due to higher interest rates can mean fewer corporate profits, investors, now in “risk-off” mode, will often scale back their stock positions, opting instead for bonds and other fixed-income assets, which may be appealing thanks to higher interest rates.

Fiscal policy hawks and doves

The hawk and dove monikers don’t just apply to monetary policymakers; there are fiscal hawks and fiscal doves as well. Fiscal policy—the levels of taxation and spending by governments—can also affect how quickly the gears of economic growth are moving. In the 21st century, deficit spending is the norm in the U.S. and other developed nations.

When the economy slows (e.g., during a recession or, more recently, a pandemic), fiscal deficits typically experience a dovish expansion. To smooth out the economic cycle—as famed economist John Maynard Keynes suggested—the hawks should tighten the fiscal purse strings during boom times. But that takes discipline.

And then there’s a flip side: A dovish Fed move is like the DJ suddenly cranking up the volume and switching from a slow jam to a faster dance track while the party host spikes the punch bowl with a mood-lightening spirit.

Wall Street loves this because lower interest rates (i.e., money flowing into the economy) can translate into more spending and profits.

For businesses, lower interest rates encourage investment in strategic initiatives, infrastructure upgrades, and maybe even a merger or acquisition. Investors join the action, purchasing shares in the stock market as increased corporate profits drive higher expected returns.

In short, the stock market tends to decline (at least in the short term) when the Fed takes a hawkish stance and hikes interest rates. Conversely, a dovish monetary policy stance tends to boost the stock market.

Many factors can affect the stock market and economy besides monetary policy, but Fed policy exerts a strong influence in guiding both.

The bottom line

The hawks and doves at the Federal Reserve can significantly sway the bulls and bears of Wall Street. Tightening or loosening the flow of money will likely elicit a strong response in market sentiment and action before the effects are felt in the broader economy. Finding the right balance—enough to make the economic cycle less disruptive—is what this balance is all about.

That’s the repeating cycle. When the bulls run, the hawks fly in to make sure it doesn’t turn into a rampage. And when the grizzly bear claws come out, the doves fly in to nurture and heal. When things have settled down, the bulls resume their run.

References

Monetary Hawks and Doves | mises.org

This article was most recently revised and updated by Karl MontevirgenThis article was most recently revised and updated by Doug Ashburn