How does monetary policy affect asset prices?

This is an issue that comes up all the time; so let me try to put things in perspective:

1.  Asset prices are procyclical, dropping sharply in slumps like 1929-33, 1937-38, 2000-02, and 2007-09.  (This entire post focuses on real asset prices.)

2.  Interest rates are also strongly procyclical.  Thus interest rates and asset prices often tend to move in the same direction.

3.  When interest rates fall for reasons other than the business cycle, asset prices tend to rise.  Thus if rates fall due to a global savings glut, it will tend to raise asset prices.  That’s the most likely explanation for the asset price boom of 2009-15.

4.  What about monetary policy?  Asset prices tend to rise when monetary policy is easier that expected.  But on closer examination it seems like real stock prices don’t “like” either easy or tight money, stocks like stable money.  Stocks do very well in low inflation booms (1920s, 1980s, 1990s, etc.) and do poorly during either deflation (early 1930s, 1938, 2009) 0r high inflation (1966-81).  Thus it would be more accurate to say that stable money is good for stocks, not easy money.  The January stock slump is accompanied by lower interest rates, but not caused by lower interest rates.  It’s caused by the thing causing lower interest rates (lower NGDP growth expectations—and hence tighter money.)

5.  David Glasner did a study that suggests stocks tend to rise strongly on easier money (bigger TIPS spreads) precisely when deficient AD is a serious problem.  That shows that asset markets “root for” sound monetary policy.   In the 1980s, asset prices rallied on tighter money (lower NGDP growth.)

Conclusion:  Monetary policymakers are probably unable to create bubbles, even if they try.  That’s because asset prices will be highest when policy is boring and appropriate.  Monetary policymakers can create asset price crashes by doing crazy stupid things, but they cannot push real asset prices higher than they would be with sound policy.  Trump might say that asset prices like situations where “America wins.”

This post is similar to a post I did over at Econlog (which is the better post, BTW.)  There I pointed out that wage growth usually slows when RGDP growth slows, but paradoxically lower wage growth causes higher RGDP growth.  And interest rates usually fall when NGDP growth slows, but paradoxically when the Fed cuts its target rate that causes NGDP growth to rise.  Now we can see that interest rates usually fall when asset prices crash, but paradoxically a Fed target rate cut usually boosts asset prices.

The failure of reporters to internalize the implications of these paradoxes explains much of the nonsense you read in the media, such as the current popular theory that Chinese devaluation is deflationary.  The real issue is, “does Chinese devaluation cause other central banks, in places like Brazil, to run more deflationary monetary policies?”  Or, “does Chinese devaluation reflect weak growth, cause stronger growth, or both?  And what is the independent effect of each of those factors?

PS.  A comment by Kevin Erdmann over at Econlog anticipated some of my thinking on this issue.

 

I will be traveling today, not much time for comments.


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44 Responses to “How does monetary policy affect asset prices?”

  1. Gravatar of E. Harding E. Harding
    26. January 2016 at 06:04

    “In the 1980s, asset prices rallied on tighter money (lower NGDP growth.)”

    -Did they, now?

    https://research.stlouisfed.org/fred2/graph/?g=3fj8

    Sure, they rose faster after August 1982 than simple NGDP growth would anticipate, but there was strong NGDP growth after 1982. Maybe markets were expecting more NGDP growth (with higher inflation).

  2. Gravatar of Steven Kopits Steven Kopits
    26. January 2016 at 06:29

    Scott –

    You had asked me about nationalist economic policies and how these adversely affect growth, and I have not had a chance to reply.

    For now, let me quote the WSJ from today, as it gives insight into the essential nature of nationalist governance:

    “… [T]he problem stems from higher up. President Xi Jinping has centralized economic policy-making in his own hands, and he doesn’t take criticism well. Late last year, as economic uncertainty climbed, the Communist Party issued disciplinary instructions outlawing “improper discussion” in its ranks, shutting off yet more feedback loops.

    “As is often the case when the leadership feels besieged, state media is lashing out at foreigners. Last week, Xinhua News Agency blamed “reckless speculations” and “vicious shorting activities” from overseas for the turmoil, and warned of unspecified “severe legal consequences” for those responsible.

    “Such threats, if carried out, will only exacerbate the crisis of confidence. Speculators aren’t just shorting the currency; they’re selling China itself.”

    That’s what I meant.

    http://www.wsj.com/articles/yuans-fall-is-just-noise-amid-deeper-china-woes-1453781114

  3. Gravatar of Art Deco Art Deco
    26. January 2016 at 06:42

    Monetary policymakers are probably unable to create bubbles,

    I see you’re trolling Steve Hanke.

  4. Gravatar of Ray Lopez Ray Lopez
    26. January 2016 at 06:58

    What is striking about Sumner is that he assumes money supply anticipates NGDP. But in fact it’s coincident at best. That doesn’t let Sumner pontificating however, as E. Harding points out, facts be damned.

    As for this ludicrous statement: “Asset prices are procyclical, dropping sharply in slumps like 1929-33, 1937-38, 2000-02, and 2007-09” – it explains nothing, as “procyclical” begs the question (it assumes the economy moves in response to the money supply rather than coincident to it). A better explanation is in fact a Kondratiev wave, which has been shown using spectral analysis to exist in modern economies (with a fifty year period), see more here: https://en.wikipedia.org/wiki/Kondratiev_wave

  5. Gravatar of TravisV TravisV
    26. January 2016 at 06:59

    Yglesias praises Bernie’s recent op-Ed on the Fed:

    http://www.vox.com/2016/1/26/10829888/bernie-sanders-federal-reserve

    “Bernie Sanders has the most realistic plan to boost wages and job creation”

  6. Gravatar of TravisV TravisV
    26. January 2016 at 07:00

    Does Bernie Sanders still believe in MMT? Is Stephanie Kelton still his top economic advisor?

  7. Gravatar of Benjamin Cole Benjamin Cole
    26. January 2016 at 07:22

     Stocks do very well in low inflation booms (1920s, 1980s, 1990s, etc.) and do poorly during either deflation (early 1930s, 1938, 2009) 0r high inflation (1966-81).—Scott Sumner.

    Agreed!

    Except no longer are the 1980s and 1990s regarded as “low inflation” decades by Fed borgers and tight-money hysterics. Janet Yellen would rather admit to bestiality fantasies than call 4% inflation “low.”

    Indeed, it is semantics, but Sumner could also write, “The US stock market boomed in the 1980s and 1990s, periods marked by moderate inflation, and inflation often double today’s Fed ceiling-rate of 2%.”

    The economy did great too.

    So why the 2% inflation ceiling?

  8. Gravatar of Art Deco Art Deco
    26. January 2016 at 09:34

    Except no longer are the 1980s and 1990s regarded as “low inflation” decades by Fed borgers and tight-money hysterics. Janet Yellen would rather admit to bestiality fantasies than call 4% inflation “low.”

    To which price index are you referring? The mean annual rate of increase in the GDP deflator was as follows during these periods:

    1965-1982: 5.96%
    1982-1991: 3.35%
    1991-2001: 1.92%
    2001-2009: 2.27%
    2009- : 1.57%

    One might think goals and perceptions during the second period might be influenced by what was up during the 3d period.

  9. Gravatar of Art Deco Art Deco
    26. January 2016 at 09:35

    Er, during the 1st period. Time runs forward, even for Greenspan.

  10. Gravatar of TravisV TravisV
    26. January 2016 at 09:38

    Awesome!

    http://www.businessinsider.com/china-warned-george-soros-against-war-on-the-renminbi-2016-1

    “China warns George Soros against going to ‘war’ on its currency”

  11. Gravatar of Matt Waters Matt Waters
    26. January 2016 at 10:03

    With deficient AD, asset prices are all about utilization. Since 2008, there have been many variants of the following sentence in both business media and investor reports:

    “QE and ZIRP are an unsustainable policy which has propped up asset prices because politicians are putting the present ahead of the future.”

    There have been years of rising asset prices and profits since 2009. How exactly does the Fed make “unsustainable” profits? If the profit of GE goes up, that’s because of real things bought by real people. The Fed doesn’t buy wind turbines or switchgears. One assumes the buyers are usually rational, in an Econ 101 way.

    With deficient AD, asset prices become correlated with each other as monetary policy has exogenous effects on the utilization of ALL companies’ assets. That follows from sticky wages, where labor slack also reduces utilization of assets and thus NPV. For business media and some investors, it’s in their interest to make the correlation sound complicated and/or make “QE and ZIRP” sound dire so we can return to a “normal interest rate environment.”

    Really, it’s not that complicated. But the non-complicated version also doesn’t fit the CNBC view of monetary policy.

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    26. January 2016 at 10:31

    You could fill a coffee table book with pairs of things people believe that are mutually exclusive and both wrong.

    For instance, after a couple of decades that have probably been the most volatile, least profitable period for capital owners since the Great Depression, it seems that everyone believes both of these things:

    1) The Fed has been lining the pockets of Wall Street by pumping up assets with loose money through QE.

    and

    2) The Fed has been lining the pockets of Wall Street with low inflation and stability, at the expense of workers. (See the Yglesias post TravisV linked to.)

    As a general rule, in the year 2015, I think one might do best by approaching most public controversies by identifying the pretext and believing the opposite of the pretext.

  13. Gravatar of Sd0000 Sd0000
    26. January 2016 at 10:46

    Damodaran has a great post debunking the “Fed inflates stock prices” myth

    http://aswathdamodaran.blogspot.com/2015/09/the-fed-interest-rates-and-stock-prices.html

  14. Gravatar of Brian Donohue Brian Donohue
    26. January 2016 at 11:13

    Good post. Important topic.

    Great comment, Kevin.

  15. Gravatar of JP Koning JP Koning
    26. January 2016 at 11:49

    Another important factor is the fact that a company’s cost of goods sold and depreciation are based on historical cost. This has the effect that when the price level is falling, a firm is shielded from taxes. When the price level is rising, it creates phantom profits and artificially boosts their tax bill.

    While a stable price level is nice, an owner of a shares does very well in a world with a boom twinned with growing disinflation (or growing deflation), given the above tax effects.

    http://jpkoning.blogspot.ca/2013/05/a-stock-portfolio-is-bad-hedge-against.html

  16. Gravatar of Chuck Chuck
    26. January 2016 at 12:15

    “it seems that everyone believes both of these things:

    1) The Fed has been lining the pockets of Wall Street by pumping up assets with loose money through QE.

    and

    2) The Fed has been lining the pockets of Wall Street with low inflation and stability, at the expense of workers. (See the Yglesias post TravisV linked to.)”

    1) Is the tight money view and 2) is the easy money view. Can you cite someone who holds both beliefs at the same time (rather than changing beliefs over time)?

  17. Gravatar of Kevin Erdmann Kevin Erdmann
    26. January 2016 at 12:57

    Good point, Chuck. That’s the way it feels to me, but you’re right, it is probably more of two camps mostly believing mutually exclusive things. I was going to try to dig up an op-ed with the older “savers hurt by low rates / Wall Street helped by high prices” dichotomy to try to salvage my defense, but tbh, you are probably right and I exaggerated a bit.

    :-)

  18. Gravatar of W. Peden W. Peden
    26. January 2016 at 13:10

    Scott Sumner,

    What would such a relationship imply for the optimality of asset-market based monetary policies e.g. NGDP futures targeting or TIPS spread targeting?

    (Sorry to ask a vague and sceptical question, but the last chapter of my thesis is going to mostly be about such market-based monetary policies.)

  19. Gravatar of Major.Freedom Major.Freedom
    26. January 2016 at 18:09

    “What about monetary policy? Asset prices tend to rise when monetary policy is easier that expected. But on closer examination it seems like real stock prices don’t “like” either easy or tight money, stocks like stable money. Stocks do very well in low inflation booms (1920s, 1980s, 1990s, etc.)”

    Reasoning from a price change.

    What you call “low inflation booms” were in fact very high money supply and credit expansion inflation booms, which is the fuel that sparked the volatile asset price booms (and subsequent busts).

    Money was not at all “stable” during those decades. The “low price inflation” was associated with the fact that much of the money inflation went to increased demand for and thus prices od assets, and that which went to the demand for consumer goods was largely offset by productivity gains.

    Money was highly unstable during those decades.

  20. Gravatar of derivs derivs
    26. January 2016 at 19:35

    “http://jpkoning.blogspot.ca/2013/05/a-stock-portfolio-is-bad-hedge-against.html”

    You need to put A LOT more thought into that one.

  21. Gravatar of Scott Sumner Scott Sumner
    26. January 2016 at 19:41

    E. Harding, I am comparing the entire decade, to the previous decade.

    Steven, I certainly agree that nationalistic policy hurts growth, which is one reason I oppose Trump.

    JP, Yes, that’s one reason why the 1970s were bad for stocks.

    W. Peden, I see that as a very different question. There is a huge difference between the question of how monetary policy affects the price level, and how it affects the relative price of assets such as stocks and real estate. For instance, monetary policy (one time changes) only impacts prices in the long run, but doesn’t have any impact on the real value of assets in the long run.

  22. Gravatar of Ray Lopez Ray Lopez
    26. January 2016 at 20:29

    Readers: notice that Sumners, a hypocrite, says he will be not commenting since traveling but does anyway…do as I say, not as I do, typical teacher.

    @Kevin Erdmann- I doubt you answer, but here’s some questions for you:

    (Erdmann): “1) The Fed has been lining the pockets of Wall Street by pumping up assets with loose money through QE” – do you, like Sumners, think that the Fed buying problematic (junk) commercial paper from Fed member banks does NOT line the pockets of member banks, some of them being players on Wall Street?

    Second, do you feel that the Fed offering interest rates on reserves does not help member banks?

    Granted I realize I’m addressing a man who feels there was no housing bubble, so, like addressing a member of the Flat Earth society, I’m not holding my breath waiting for a rational answer.

  23. Gravatar of derivs derivs
    26. January 2016 at 20:31

    Funny.. Just found out my cousins daughter is in business studies at Bentley. S. Sachs.. female… give her an A if you ever get her in your class…

  24. Gravatar of E. Harding E. Harding
    26. January 2016 at 20:59

    “E. Harding, I am comparing the entire decade, to the previous decade.”

    -Well, then, a much better phrasing would be “they rose faster in the 1980s than in the 1970s despite lower NGDP growth in the former”.

    I’ve never heard of the stock market actually rallying on tighter money on any one day in the U.S. Would be weird and cool if it did, though.

  25. Gravatar of Benjamin Cole Benjamin Cole
    26. January 2016 at 22:00

    Kevin Erdmann:

    I concur that viewing Fed policy through a class warfare angle is not productive.

    It would be like looking at the USDA through the class glass. But the USDA might, in fact, help “poor” farmers (if there are any left). The USDA has an extensive “county agent” system and I think they help anybody who asks.

    That said, what would Fed policy be if there were permanent seats on the FOMC board assigned to the domestic manufacturing, tourism, and real estate industries? And say one seat for labor. I sense a lot less talk about the perils of inflation, and less bleating about a strong dollar.

    Is IOER really an example of “clean” public policy? Just happens to give banks money for doing nothing. They get trillions in reserves via QE, and now 0.50% for sitting on the reserves. Maybe the Fed has the USDA manual somewhere.

    I think it does make sense to keep a gimlet eye on the Fed for industry capture–and on any federal regulatory agency.

  26. Gravatar of dtoh dtoh
    27. January 2016 at 03:18

    @scott

    “The failure of reporters to internalize the implications of these paradoxes explains much of the nonsense you read in the media.”

    The only reason there are perceived paradoxes is because economists talk about “asset prices” in the first place. If they banished that term and instead talked about expected after-tax risk adjusted returns, there would not be any paradoxes.

  27. Gravatar of derivs derivs
    27. January 2016 at 04:17

    “I sense a lot less talk about the perils of inflation, and less bleating about a strong dollar.”

    Ben, have you ever lived in a country with high inflation and a weak currency (U.S. doesn’t count).

  28. Gravatar of W. Peden W. Peden
    27. January 2016 at 04:55

    Scott Sumner,

    Thanks, I think I see the distinction. What I was worried about was whether or not securing greater inflation stability via asset market-based monetary policies would cause the prices of those markets to have a boom and thus lead to greater inflation instability.

  29. Gravatar of Benjamin Cole Benjamin Cole
    27. January 2016 at 05:43

    Derivs–no. Actually, right now, is there anyone on the planet living in a country with high inflation?

    India Today has inflation in the 6% range and real growth in the 7% range.

    I guess Brazil is doing poorly with high inflation, but then Latin American nations always implode. Remember, always bet against Latin America and Africa.

  30. Gravatar of Ray Lopez Ray Lopez
    27. January 2016 at 06:40

    @Derivs– Sumner retired from teaching at Bentley. He’s on Duda’s payroll now.

  31. Gravatar of JP Koning JP Koning
    27. January 2016 at 08:18

    “You need to put A LOT more thought into that one.”

    Continue.

  32. Gravatar of Brian Donohue Brian Donohue
    27. January 2016 at 13:12

    I’m not sure what the markets were expecting from Yellen today, but they didn’t like what they got.

    I saw a passing reference to “fears of a global currency war…”

    If only.

  33. Gravatar of TravisV TravisV
    27. January 2016 at 15:33

    Excellent post by Jonathan Chait: “What Bernie Sanders Doesn’t Understand About American Politics”

    http://nymag.com/daily/intelligencer/2016/01/what-sanders-doesnt-understand-about-politics.html

  34. Gravatar of ssumner ssumner
    27. January 2016 at 20:52

    Ray, And so you don’t even know what the word hypocrite means? Most kids pick that word up by about the 8th grade.

    derivs, I don’t teach there anymore.

    dtoh, How would they talk about them, if they can’t be measured? Or am I missing something?

    W. Peden, I don’t see that happening, but I may be missing something.

  35. Gravatar of dtoh dtoh
    27. January 2016 at 21:33

    @scott

    “How would they talk about them, if they can’t be measured?”

    The same way corporate bond traders quote bonds in yields, option traders quote options in volatilty and real estate investors buy on yield.

    In the case of a sphere; radius, circumference and volume all give you the exact same information. The choice depends on which is most convenient to the circumstances. For understanding monetary policy, “return” is a much more useful measure.

  36. Gravatar of derivs derivs
    28. January 2016 at 04:39

    “and instead talked about expected after-tax risk adjusted returns, there would not be any paradoxes.”

    dtoh, I tried illustrating that recently.. econ people don’t do finance.

    loved the sphere analogy, i will be borrowing that one day… as an fyi.. options are almost always quoted as price. x vol on 1 model will not be the same as x vol on someone elses model.

  37. Gravatar of Scott Sumner Scott Sumner
    28. January 2016 at 13:51

    dtoh, What is the current expected, after tax rate of return for the S&P500, over the next 5, 10 and 20 years, and where do I look it up?

  38. Gravatar of dtoh dtoh
    28. January 2016 at 16:43

    @scott
    I said “risk adjusted” after tax rate of return. It’s easy. It’s the yield on US Treasury securities x (1 minus the tax rate).

    Unless you don’t believe in EMH.

  39. Gravatar of ssumner ssumner
    29. January 2016 at 13:01

    dtoh, OK, but then you are really just talking about the yield on T-bonds.

  40. Gravatar of derivs derivs
    29. January 2016 at 13:54

    Scott,
    If you believe in random walk why would you expect it to be positive???
    A bit more complicated than what dtoh is saying since you have variable dividend streams but what he is saying is 98%+ correct. Think binomial distribution… it will eventually click.

  41. Gravatar of derivs derivs
    29. January 2016 at 13:58

    look at dec19-dec20 SPX settlements and you will see the spread is about 1%. Can’t remember as it is way too many years for me now but pick up something like Hull and study forward K parameter. An overall fun book to read, meant only for very high level academics of course.

  42. Gravatar of dtoh dtoh
    29. January 2016 at 14:10

    @scott

    “OK, but then you are really just talking about the yield on T-bonds.’

    Precisely, but it is much clearer to describe it as expected risk adjusted returns on assets, which avoids the need for economists and journalists to chase their tail trying to explain asset prices. With respect to monetary policy, interest rates/TSY yields (i.e. expected risk adjusted returns on assets) provide exactly the same information without any apparent “paradoxes.”

  43. Gravatar of derivs derivs
    29. January 2016 at 14:55

    Scott.. Goog settled 743 today. If I asked to buy June ’16 Goog from you, where would you price it?

    Funny you are back in the convo I tried teaching this to you on inflation/interest rates…

  44. Gravatar of ssumner ssumner
    30. January 2016 at 07:46

    derivs, Have no idea what you are asking me.

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