January 28, 2008
A helpful suggestion for the Fed
It is now clear beyond a reasonable doubt that the Fed wants to prevent sudden sharp drops in the stock market. It has not, however, drawn the logical conclusion from this endogenous widening of its mandate. So instead of pussyfooting around with 75 basis point cuts in the target for the Federal Funds rate, I propose that the Fed put its money where its heart is by engaging in outright open market purchases of US stocks and shares.
By intervening through the purchase of the most broadly-based value-weighted index of US stocks, e.g. the Wilshire 5000 Total Market Index, any unlevelling of the playing field between listed stocks can be avoided. I would prefer the Fed to acquire only non-voting shares, or to put any shares it acquires in a blind trust, to avoid any temptation to micro-manage the enterprises whose shares it purchases. On January 25 the Wilshire 5000 index stood at 13,423.62. The 52-week peak was on October 7, 2007 at 15,806.69. Let’s split the difference and request the Fed to put a floor below the Wilshire 5000 at, say, 14,500.00. If the Hong Kong Monetary Authority can make large-scale domestic equity purchases during the Asian Crisis in 1998, the Fed can make large-scale domestic equity purchases during the North Atlantic Financial Crisis in 2008.
What I propose is effectively the same as the Fed attaching a free put option to every equity share in a US-registered and-listed enterprise. It would put paid forever to all those jokes about the Greenspan put and the Bernanke put.
Let’s do it!
Willem,
Posted by: Matthew Power | January 28th, 2008 at 11:46 pm | Report this commentYour assertation that a 0.75% cut to prevent a drop in the stock market is ‘pussyfooting around’ may be true. Might a 0.75% drop, to ease liquidity in order to save the US municipal bond market (currently around $2.5 trillion) be viewed diferently?
If the Fed were to get directly involved in the markets, rather than indirectly - say via the PPT or increasing the money supply when deemed necessary - would this not destroy the markets’ integrity?
I find this sort of thing to be rather arrogant and unhelpful to an intelligent discussion of monetary policy. Could it be remotely possible, Mr Buiter, that the most powerful central bank in the world might actually know something you do not?
I seem to remember from Econ 101 that equity markets are a leading indicator, after all.
Posted by: David | January 29th, 2008 at 11:00 am | Report this commentDavid, are you suggesting that Willem B. “learn the art of silence”?
Posted by: otto | January 29th, 2008 at 11:09 am | Report this commentYou mean à la “missing a great opportunity to shut up”? Of course not.
I just think we’ve all had quite enough of punditry on US monetary policy for a week (or perhaps a year). The buzz from the FT columns generated by the US slowdown is, for lack of a better word, gleeful. I suppose that if this turns out to be effective policy (and it will take a year, not a week, to judge), we will be treated to monotonous tirades about “global economic imbalances” and “asset bubbles” until we’re all blue in the face. It’s enough to make one resort to reading the WSJ editorial page, but that may be going a bit far.
Posted by: David | January 29th, 2008 at 11:22 am | Report this commentThis is simply brilliant! Let the Parrrr-tay begin!
Posted by: Ronnie M. Honduras | January 29th, 2008 at 2:14 pm | Report this commentYou’re all joking, right? Or has it really come to this: the Federal Reserve, otherwise known as the Central Planning Commission, working on some Five Year Plan? One never knows these days.
Posted by: N. Schoess | January 29th, 2008 at 4:41 pm | Report this commentWhy stop there? Why not have the Fed explicitly target the total return index of the Wilshire 5000, so that it grows along a crawling peg at (say) 7% per year (5% average real return plus 2% inflation)?
Posted by: Nick Rowe | January 29th, 2008 at 6:22 pm | Report this commentLet us not confuse the means with the end: our objective is economic stability, not interest rate non-volatility.
Posted by: Ron Cohen-Seban | January 29th, 2008 at 10:15 pm | Report this commentGiven the high correlation between Wilshire 5000 and other indices lately (look for yourself) maybe it’s already happening.
And anyway, the Fed is already accepting garbage collateral and has taken over from the market the provision of banking reserves. The Fed these days is like the economy’s heart-lung machine, breathing for us until maybe someday we can breathe on our own again.
Posted by: David Quinn | January 29th, 2008 at 11:22 pm | Report this commentGreat idea! and let’s appoint Warren Buffet as Fed chairman (though he might turn out a more discriminating buyer than Mr. Bernanke)
Posted by: Domi | January 29th, 2008 at 11:48 pm | Report this commentUtterly brilliant! Except for one thing: such a move, while making sense in light of the fact that, for the past 2 decades, the Fed has done nothing but intervene in order to prop up asset prices (i.e. The Endless Bubble) would remove what Ben Bradlee once coined as the “Non-Denial Denial”. It’s one thing to prop up the market. It’s quite another to be utterly blatant about it, no matter how many people you’re not fooling.
In response to David’s comment that perhaps the world’s most powerful central bank knows something the author doesn’t, I would find this plausible (and I truly mean no disrespect to David) had Bernanke and Co. not completely whiffed on the effect the subprime mess would have on the U.S. economy. It was just this fall when both Bernanke and US Treasury Secretary Hank Paulson claimed all was well and the problem was “contained”. Only after the writedowns from major US banks occurred did either begin to alter his stance.
I find this to be both totally ignorant and completely inexcusable, particularly given the fact that there has been no shortage of economists, investors and analysts (although they have been in the vast minority) who have been writing for over a year about the potential hazards of our newfound financial alchemy. Warren Buffett, back in 2004, proclaimed derivatives to be financial weapons of mass destruction. Bob Prechter, in 2002, predicted the credit and asset bubble, particularly the one in housing. Jim Rogers, Marc Faber and Nouriel Roubini are among others who have warned of this.
The Fed has been willingly blind all of these years. The cause of this is beyond my knowledge. I can only suggest that perhaps if they had not pursued such an asymmetric monetary policy for so many years, the world’s most powerful central bank may have considered that printing endless streams of money, flooding the economy with cheap credit and utterly failing to regulate the lending industry might have adverse affects. As far as I’m concerned, the Fed lost all of its credibility years ago, and I have no faith the Helicopter Ben will do anything to restore it.
Posted by: Peter Davis | January 30th, 2008 at 7:10 am | Report this comment