Should the Fed pay attention to the stock market?
By Scott Sumner
This Bloomberg article caught my eye:
Donald Trump loves to bash Jerome Powell, blaming him for the market meltdown. And while people can debate if the hectoring is a good idea and whether the Federal Reserve cares about stocks, it’s getting harder to argue the president is totally wrong.
Signs of Fed-fomented stress are everywhere, from slumping bank stocks to the 33 percent plunge in home builders since January. They’re in the market’s newfound willingness to differentiate between defensive and cyclical stocks, a bias absent from past meltdowns. They’re in the giant yawn greeting stellar earnings, evidence investors have something else on their mind.
The fundamentals are strong, goes the refrain, and the economy can absorb some tightening. But with eight rate hikes in the book already and more to come, it’s obvious many investors are feeling otherwise.
I can’t agree with the “it’s obvious” in the final sentence. When it comes to equity markets and monetary policy, it’s usually hard to establish a link without high frequency data showing an immediate market reaction to news about Fed policy decisions. It’s true that stocks are somewhat correlated with monetary policy, but stocks are also correlated with lots of other factors that might impact corporate profits.
Later in the same article we get a more defensible claim:
[W]hile stocks are clearly their own animal, all hair-trigger volatility and bloated valuations, the possibility they are acting as a warning signal for the rest of the economy shouldn’t be discounted.
“Shouldn’t be discounted” is much better. Stocks are one of many factors that should be considered when setting monetary policy. But this raises another question. If the Bloomberg reporter is correct that market signals are useful to monetary policymakers, and I think she is correct, then why don’t reporters spend more time discussing the need to create a highly liquid NGDP futures market? I see lots of articles discussing the need for better policies in areas like health care, global warming, housing development, occupational licensing, inequality, and other areas of concern. So why isn’t there a clamor for a better market indicator of aggregate demand?
It’s not just Bloomberg; lots of media outlets discuss the relationship between the stock market and monetary policy. Far fewer discuss the relationship between TIPS spreads and monetary policy. And still fewer discuss the need for a direct market indicator of aggregate demand expectations. And it’s not just ideology; both the left and right wing media are equally silent on this issue.