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Thursday, May 16, 2013

Fed Watch: Lumping Everything into the Wealth Effect

Another from Tim Duy:

Lumping Everything into the Wealth Effect, by Tim Duy: After posting my review of Martin Feldstein's WSJ op-ed, I waded through Dallas Federal Reserve President Richard Fisher's latest speech and found this:

The former outcome is that envisioned by the theoreticians that lead the Fed: According to this plot, by driving rates to historical lows along the entire length of the yield curve, investors will rebalance their portfolios and reach out to riskier assets, providing the financial wherewithal for businesses to increase capital expenditures and reengage workers, expand payrolls and regenerate consumption. Rising prices of bonds, stocks and other financial instruments will bolster consumer confidence. The CliffsNotes account of this play has the widely heralded “wealth effect” paving the way for economic expansion, thus saving the day.

The latter outcome posits that the wealth effect is limited, for two possible reasons. One is that our continued purchases of Treasuries are having decreasing effects on private borrowing costs, given how low long-term Treasury rates already are. Another is that the uncertainty resulting from fiscal tomfoolery is a serious obstacle to restoring full employment. Until job creators are properly incentivized by fiscal and regulatory policy to harness the cheap and abundant money we at the Fed have engineered, these funds will predominantly benefit those with the means to speculate, tilling the fields of finance for returns that are enabled by historically low rates but do not readily result in job expansion. Cheap capital inures to the benefit of the Warren Buffetts, who can discount lower hurdle rates to achieve their investors’ expectations, accumulating holdings without necessarily expanding employment or the wealth of the overall economy.

Is it just me, or is Fisher being explicitly derisive about the wealth effect? And when did we start lumping all the channels of monetary policy into the "wealth effect"? The wealth effect is but one channel of monetary policy. See something like this graphic from Frederick Mishkin's money and banking textbook:


While equity prices do operate through a number of channels, only one of those is the "wealth effect." To his credit, Fisher has a more sophisticated view of those channels than Feldstein, who appears to limit the impact of QE to the strict definition of the wealth effect:

That drives up the price of equities, leading to more consumer spending.

But even if Fisher does see the bigger picture, should he really be lumping together all the channels of monetary policy into the "wealth effect?" Doing so only feeds the bias against monetary easing by perpetuating the view it is about nothing more than creating an artificial boost of equity prices and benefiting speculators rather than stimulating the economy via a number of channels that subsequently enhance the profitability of firms and thus raises equity prices.

Of course, Fisher and Feldstein are deliberately trying to perpetuate a bias against quantitative easing. And even after all these years, I still find it odd that Fisher appears to believe his job is to undermine the institution that provides his employment.

    Posted by on Thursday, May 16, 2013 at 01:34 PM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (9)



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