By Scott Sumner
I’d like to make readers aware of a site called EconTalk Extra. There is a very good recent post by Amy Willis discussing my EconTalk conversation with Russ Roberts. Unfortunately I didn’t respond to comments until this morning, as I just returned from a trip. So if you left a comment last week then go take another look.
It probably worth saying a bit more about the first comment, which pointed to the widely held perception that monetary stimulus has boosted asset prices without significantly helping the economy. There is a grain of truth in the asset price effects, but I believe people tend to overestimate the “Cantillon effects.”
In recent years the demand for bank reserves has been very strong, mostly due to near-zero nominal rates, but also the 0.25% interest-on-reserves program. The QE injections have mostly served to prevent an even slower recovery. Here you might contrast the US with the eurozone, where the ECB did less monetary stimulus and the recession took a double dip after 2011.
So in my view the Fed’s QE actually boosted asset prices by preventing a worse macro outcome. I do understand why people disagree with me; the recently soaring stock prices seem much too dramatic to explain by the modest economic recovery in the US. And that’s because at the same time the Fed has been doing QE, the global economy has been buffeted by “stagnation” forces that seem to have depressed equilibrium real interest rates, even on very long-term bonds. And yet despite the weak economy, corporate earnings are pretty good. If you discount strong corporate earnings with low real interest rates, you end up with high asset prices. But the Fed plays only a very modest direct role in the low rates.
In 1928 and 1929 things were a bit different. The global economy still had relatively high short-term real interest rates, and then in the late 1920s the Fed raised them even higher, with the goal of popping the stock market bubble. In the end they “succeeded,” but it’s more interesting to consider the 18-month period when they failed, early 1928 to late 1929. Why did the continual increase in interest rates fail to pop stock prices until the fall of 1929? The answer seems to be that macro conditions are much more important than the short term interest rates that are affected by monetary policy. Stock prices plunged only when the economy began a sharp nosedive in the fall of 1929.
The real interest rate was much higher in the late 1920s than today, but in both cases we see asset markets responding more to macroeconomic events than to the (liquidity effect of) monetary policy. That’s not to say monetary policy is not important, but it’s mostly important to the extent that it impacts the key macro variables, not because it swaps one interest-bearing Federal government liability for another interest-bearing Federal government liability.