The Second Stupidest Argument

In yesterday's installment, the explanation for why there is no housing bubble was identified as being the stupidest argument of recent times. Today, we discuss the second stupidest argument - that the Fed should not and will not "target" asset prices when formulating monetary policy.

The second stupidest argument works in combination with the first stupidest argument and the truism of the "wealth effect" to go a long way in explaining how the crazed American consumer, and hence the U.S. economy, both seemingly continue to prosper.

This argument goes back almost ten years, originating around the time that "irrational exuberance" morphed into "productivity miracle". The Fed's position on asset prices and monetary policy since that time has been consistent and has always been framed by the use of the word "target", allowing them to answer a different question than they are asked - subtle misdirection at its best.

When queried with something like "Shouldn't you think about raising interest rates when it is obvious that easy money is causing asset prices to rise dramatically?" The reply is a sharp "the Fed does not make asset prices the targets of policy" or "the Fed can not target a particular level of asset prices". What this (by now reflexive) response does is answer a different question - instead of answering "Shouldn't you do something about the alarming rise in asset prices?" or "Shouldn't the alarming rise in asset prices be important in policy decisions?" they answer the question "Why aren't rising asset prices the sole driver of monetary policy".


Very clever - a good offense is always better than a good defense.

So, let's look at a specific case. In this 2004 speech, Easy Al discusses the relationship between asset prices and monetary policy:

In addition to the narrower issue of product price stability, asset prices will remain high on the research agenda of central banks for years to come... There is little dispute that the prices of stocks, bonds, homes, real estate, and exchange rates affect GDP. But most central banks have chosen, at least to date, not to view asset prices as targets of policy, but as economic variables to be considered through the prism of the policy's ultimate objective.

Yes, asset prices are high on the list of things that will be looked at - more research will be done. Well, at least they're doing something. But, what's this part about "most central banks have not chosen to view asset prices as targets of policy"? You're the head of the biggest central bank on the planet, and you're saying "Well these other guys aren't doing it, so I'm not going to do it". What kind of lame excuse is that?

So asset prices will be studied, but until then, they will not be targeted - they will be considered, along with myriad other factors, in pursuit of the ultimate goal of price stability and full employment. Product price stability that is, not asset price stability - that's a different kind of price, a kind of price that exhibits very little stability, actually.

Well the neat trick here, obvious to anyone doing any thinking at all, is that if you don't consider stock/housing prices, you can fuel a stock/housing boom with cheap money and create all kinds of stock/housing jobs, and as long as you exclude stock/housing prices from whatever it is that you do "target" when it comes to prices, then you've gone a long way toward accomplishing the goal of price stability and full employment.

Hey, they've been doing this since 1995! How long can this g