The American Enterprise Institute recently had a symposium on QE after 10 years. It began with Desmond Lachman interviewing Ben Bernanke. At one point Lachman asked about the influence of asset price increases on demand. Lachman referenced studies that estimated an impact of 4 cents on the dollar, presumably meaning that an extra dollar in aggregate wealth leads to an extra 4 cents of aggregate demand.

Should we take those estimates seriously? I’d say no, for a wide variety of reasons. Most importantly, they overlook two serious problems, which make any sort of wealth effect unreliable. These are “never reason from a wealth change” and “monetary offset”. Let’s start with never reason from a wealth change.

It’s impossible to know the impact of a change in wealth without first knowing why wealth has changed. Thus suppose that wealth increases because real interest rates have fallen (a very plausible assumption, BTW, regarding asset prices increases during the 21st century.) In that case, it’s not clear that people would have any incentive to spend more than before.

Think about the following example. We start with a country with $1 trillion in wealth, all in land. Interest rates are 4% and the land yields an income of $40 billion per year. People consume 70% of that figure. Now assume that the global real interest rate falls to 2%. The value of the land doubles, to $2 trillion. But the flow of income from the land does not change, staying at $40 billion. So why would the public spend more? After all, their flow of income has not changed.  One could do a similar example with common stocks and a changing P/E ratio.

The lesson is that one should never reason from a wealth change; first consider why the total stock of wealth has changed.

Now let’s assume that wealth goes up because our economy is becoming more productive, yielding a higher expected future flow of income. In that case can we expect more nominal spending? Maybe, but not because wealth has risen, rather because aggregate supply has risen and the central bank is targeting inflation. Thus real GDP will rise as inflation stays stable–which leads to more NGDP.  On the other hand, if the central bank were targeting NGDP, then a positive supply shock would not boost nominal spending, due to monetary offset. Aggregate demand should be stable under NGDP targeting; hence under that policy regime any wealth effect estimates are nothing more than an estimate of central bank incompetence.

The US has seen an enormous growth in wealth since 2011, and yet productivity growth remains sluggish. Thus no one should be surprised that aggregate demand continues to grow quite slowly. As wealth rises, the Fed raises interest rates fast enough to keep inflation close to 2%.

PS. The symposium on QE had four panelists. Three gave talks full of vague warnings about possible financial imbalances, but with no plausible explanation as to why this should impact the stance of monetary policy. In contrast, Joe Gagnon gave an excellent defense of QE, and also several themes that market monetarists have emphasized. Here is a slide from his presentation:

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Nominal GDP targeting, level targeting, and target the forecast. If we had done those three things in 2008-09, the recession would probably have been far milder.