A drop in stock prices is “more than a warning sign,” Greenspan said yesterday on NBC’s “Meet the Press” program. “It’s important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity.” Bloomberg.com.
This seems to have things wrong way round. Economic activity should be what determines stock prices.
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Isn't it simply that the value ascribed to stocks can be borrowed against, so it acts as the same kind of influence on the whole economy as the Fed's control of interest rates?
ReplyDeleteDan M.,
ReplyDeleteThat's part of it, but that's exactly the problem with focusing on asset prices. When economic activity if fueled by borrowing against assets, you get bubbles like the one in housing.
If you are interested in learning more, I would highly recommend Bailout Nation by Barry Ritholtz. He gives a very good explanation of how the fed under Alan Greenspan made its primary focus asset prices which led it to engage in bailouts rather than letting economic downturns run their course.
Thanks.
ReplyDeleteI didn't mean to defend the paper profits and I was probably misreading Greenspan's "not just paper profits" to say "Sure, they're paper profits, but affect monetary stability." In retrospect, that's much less plausible.
By the way, I've been lurking here since TGirsch linked to you at some point. I've enjoyed your discussions of Paul and the lack of historical Jesus. (I'm a recovered Catholic.)
Dan M.,
ReplyDeleteThanks for reading.
I started working in the financial markets back in 1980 when Paul Volcker decided to break the back of inflation by letting short term interest rates get up above 20%. At the time, the stock market was very unhappy, but the Federal Reserve did not care. We had a very nasty recession, but when the economy recovered, the markets recovered.
Under Greenspan, the financial markets became the tail that wagged the dog. Manufacturing disappeared, median incomes stagnated, and we became the world's biggest debtor nation. Nevertheless, the great bull market in stocks followed by the great bull market in housing created the illusion of general prosperity when in fact wealth was becoming concentrated in fewer and fewer hands.