Tuesday, August 12, 2014

The Greenspan Put and the Yellen Call

In today's Guardian, I make the case for a more aggressive financial stabilization policy,  "No more boom and bust? The financial policy committee has time on its side". I argue that the Bank of England's FPC should buy shares in the stock market when the PE ratio is low, and sell them when it is high.

Kimdriver makes the following comment.
The Greenspan put with real teeth ?
My worry is that, while CAPE has historically been a good predictor of future returns, the level that the FPC should be ready to intervene would have to be set so low that it might be fairly useless. Otherwise the safety net would just encourage increased irrational exuberance.
My response ...
I am not arguing just for a Greenspan Put: but also for a Yellen Call. It is just as dangerous to allow market bubbles as it is to allow them to crash.
Read more here...


  1. Roger, if I am correct, this proposal is a corollary of your work on animal spirits and indeterminacy. However, while I find this work interesting, I have various concerns. Some are political. First, I am not sure the public will like the idea of a government agency buying stocks on behalf of the taxpayers when the taxpayers themselves are unwilling to do so. Also, labor may see it as an unfair subsidy to capital owners, especially during a recession. Second, there is the question of which companies' shares the committee should buy and when. Such a decision should be based on expectations about the future. A fixed rule (e.g. buy when P/E<X) is therefore sub-optimal, since it does not take into account the entire information set. On the other hand, discretion may allow the committee to use its power to serve selfish goals (e.g. buy/sell before an election to help/hurt the incumbent political party, buy stocks of politically-connected companies with poor prospects, etc.)

    A final concern is that under your proposal the committee essentially becomes a market-maker that can set the price of assets as it sees fit. Even if we accept that the committee is completely benevolent, there is the question of whether government bureaucrats financed by taxpayers will be better at figuring out a "fair" price for those assets. If, as in your model, the economy adjusts to justify the price "selected" by the stock market, this concern becomes irrelevant. But I am not convinced that this is the case.

  2. All good points.

    1. Public acceptability. I don't have much to say here other than: it is important to lay out the case in favor, which I am doing, and listen to the arguments for and against the proposal, which I am also doing. Ideas of this magnitude will not enter the public consciousness overnight.

    2. The right trading rule. I favor a rule based, not on the PE ratio, but the unemployment rate. If U > Ubar allow the index to grow at x%, if U < Ubar, allow it to grow at y%, where x > y. That proposal is connected with my work on the link between wealth and the real economy (see my website for links). It is also borne out by the regional evidence from Mian and Sufi.

    3. Implementing a policy of this kind is the toughest part. One suggestion is a committee composed of members with overlapping terms with long horizons and political accountability.

    4. I understand your concerns regarding the 'right price'. Anyone schooled in classical economics where there is a unique fundamental equilibrium will have difficulty accepting my proposal. Classical economics is, in my view, a fantasy. In reality, the free market forces leading us to the unique Pareto Optimal unemployment rate are weak or non-existent.

    1. "In reality, the free market forces leading us to the unique Pareto Optimal unemployment rate are weak or non-existent."

      Yes, I am not convinced that this is the case, but more often than not the market outcome seems to me a second best. Anyway, your ideas are certainly worth discussing, and I feel honored by your willingness to respond.


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