If, on the other hand, a rate cut had not been assumed to be a sure thing, the absence of one would not have been disaster. It is the Fed's own past policies that have created the assumption that the Fed will lower rates whenever there is a substantial market decline, pushing share prices back up and capping potential losses for investors. Shortly after entering office, Alan Greenspan dropped rates in response to the October 1987 stock market crash, just as he recently did with his surprise January mid-meeting rate cut after the Nasdaq's dive. Similar loosening polices were implemented in response to the Asian market meltdown. In each situation, the Fed's actions may have increased confidence about its commitment to insulating the economy from threats, but at the same time it added to the perception of the Fed as the market's sugar daddy, always standing by ready to help out.
Market corrections are by no means a sure precursor of an economic downturn.
Even now, the Fed is projecting that growth will pick up in the second half of the year. Often, stock market corrections are in order. This is most likely the case now, when stocks are returning to more normal valuations after what has been a spectacular run. Trying to mitigate the swings of the stock market not only will be unsuccessful over time, but also will be counterproductive. Expectations of a Fed safety net create a moral hazard, encouraging investors to take on more risk than they otherwise should.