Meek and mild

The title refers to the article that Greg Ip had written in Wall Street Journal on how asset prices are again driving the U.S. economy. The article cites Gail Fosler, a private economics consultant as saying the following:

Those inflated prices make it more treacherous to return interest rates to normal, the task facing the Fed as it meets this week.

Assets didn’t always matter so much. From 1952 to 1996, wealth fluctuated around 400% of national income, according to Gail Fosler, a New York-based economic consultant. Finance was highly regulated and monetary policy mostly worked by dictating how much banks would lend, at what rate. [Link]

Monetary policy that keeps an eye (or both) on asset prices is eventually trapped by asset prices to stay the course and become abnormally loose. It becomes a hostage to asset prices. That is what I wrote in my MINT column three weeks ago, while praising Mervyn King on his book and his message:

The combination of low inflation, low real investment and high speculation traps central banks in a policy of low interest rates forever. Low inflation and low investment justify interest rates remaining low, and high speculation and asset bubbles induce fear of the economic consequences of them popping. Asset markets are decoupled from economic fundamentals. Rational expectations, therefore, do not restore equilibrium but perpetuate and worsen disequilibrium. This is the reality of G-7 countries today. [Link]

Greg Ip is too polite. This is the problem the world faced in 2006-07 and people who instinctively sense that not all is well are neither bold nor loud. They are drowned out and they feel sorry that they did not shout out when it was still possible to do so. They realise it when it is too late and after the damage is done by asset prices that eventually pop.

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2 thoughts on “Meek and mild

  1. Then it means – except for restoring calm, most of current monetary policies are then useless as they mostly continue to prop up asset prices. And we can’t encourage more real investment through targeted fiscal incentives in most of developed world and places like China. Because we already suffer from malinvestment and excess capacity. So those squirrelling away savings are now letting monetary economists control inter generational pricing of money and savings – and the people who have no savings are hurt … And will remain hurt

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