On the Federal Reserve…
Are the critics right?
By Roger Scher, Adjunct Assistant Professor
Maybe in a few years time when economic historians look back on this period of monetary history, the reluctance of policymakers to specifically target excessive asset price appreciation and financial stability (i.e. stock market and real estate bubbles) as policy goals will look as antiquated as say mercantilism looks to us today. Maybe not.
The focus on consumer price inflation as the exclusive policy objective (at times) may appear to future analysts as driven by some sort of theocratic zeal — evidenced by many of today’s Fed critics. Time will tell.
Time will also tell if we will have another global inflation bout like in the 1970s and today’s Fed critics will be proven right… and me wrong. So, go ahead and blame financial market excesses, which wallop us (especially the poor) every decade or so it seems, on excessive monetary accommodation. But perhaps central banks had no choice but to accommodate or be cast as Herbert Hoovers or late 1920s Fed officials. See the chart below.
I have the sneaking suspicion that debt and financial bubbles should be a target of monetary policy, used in tandem with macro-prudential measures when needed. So I might have begun tightening when PEs and real estate valuations became rich even before the post-pandemic period. That said, I am profoundly unsure about how this episode will turn out and sometimes wish Fed critics could be the same…
Notes: The Robert Shiller Price-Earnings ratio for the S&P 500 stock market index still shows how expensive stocks are, and how markets continue to dismiss political risk. The PE ratio in the graph above shows the price of stocks relative to the previous 10 years of earnings. Stocks today are the most expensive they’ve been in 20 years. The last data point is April 2022. Note the high levels of the PE ratio (i.e. stock prices) just before the 1929 and 2001 Dot-com crashes, levels we are close to today. Above is a “total return concept” that Yale economist Shiller now calculates. Shiller points out that “changes in corporate payout policy (i. e. share repurchases rather than dividends have now become a dominant approach in the United States for cash distribution to shareholders) may affect the level of the CAPE [PE] ratio through changing the growth rate of earnings per share… A total return CAPE corrects for this bias…”