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Thursday, August 02, 2007

A Greenspan or Bernanke Put?

The recent stock market movements have rekindled talk of the "Greenspan Put," but there are questions about whether such a put has ever existed:

Central Bankers Won't Jettison 'Greenspan Put', by Matthew Lynn, Bloomberg: As global markets wobbled nervously last week, one thought appeared uppermost in the minds of many investors: If this gets nasty, then Alan Greenspan isn't going to be standing by to bail us out this time.

The ''Greenspan put'' -- the helpful way the former Federal Reserve chairman responded to big declines in the stock market by delivering a cut in interest rates -- is assumed to have left the building along with the man himself.

The current ruling clique of central bankers -- Ben Bernanke at the Fed, Jean-Claude Trichet at the European Central Bank, and Mervyn King at the Bank of England -- is thought to be made of sterner stuff. Anti-inflationary discipline is the new mantra. If stock markets collapse, and lots of overpaid hedge-fund managers get burned, then so what? It's not the job of central bankers to ensure rising equity prices.

But hold on. Who says they wouldn't do much the same as Greenspan if faced with a similar set of circumstances? If there was any evidence that the steady increases in global interest rates over the past year were going to create a sustained bear market, central banks would certainly act.

What else are they meant to do? Sit idly by while the global economy slips into recession? The truth is, the ''Greenspan put'' will outlive its creator. ...

It isn't evidence of "a sustained bear market" that would cause the fed to act, the Fed would only act if it feared slowing economic activity generally. To the extent that stock prices and the state of the economy are correlated, and the short-run correlation is not all that large, it may appear that the Fed is moving to prop up asset values, but that is only a by-product of the Fed's attempt to stimulate activity more broadly, policy is not directed at the stock market itself. St. Louis Fed president William Poole explains:

Much of the time, I believe, stock price changes do reflect reasoned information about future earnings growth. Thus, my first instinct is to interpret stock market changes as reflecting probable changes in future earnings, which in turn may reflect emerging trends in the economy. ... This information is obviously relevant for monetary policy. Unfortunately, stock prices have a significant overlay of noise-uninformative, short-run fluctuations-that makes it highly problematic to put much weight on the stock market in reaching judgments about the appropriate course of monetary policy. Moreover, it does seem that some changes in market prices reflect an irrational component. I do not believe that anyone will ever find simple, straight-forward measures of the irrational component, or regularities that will permit us to determine reliably that the stock market is significantly over- or under-valued.

So, again, the Fed does not focus on asset values per se, they are only important to the extent they signal broader changes in the economy.

Finally, it is commonly assumed that a Greenspan put existed, but did it? Let me turn it over to Brad DeLong who has looked into this question:

A "Greenspan Put"?, by Brad DeLong: Four years ago Barry Eichengreen and I wondered whether the "Greenspan Put" had been a powerful force pushing up lending to high-risk countries in the mid-1990s and pushing up stock prices during the dot-com bubble. But we found a problem: we couldn't find significant evidence that this was the case--indeed, we couldn't find that many mentions of the "Greenspan Put" in the financial press or the financial newsletters in the first place. If it was part of the Zeitgeist, it wasn't in any place very visible to us.

The idea of an important "Greenspan Put" lost plausibility as the Federal Reserve did not take steps to lower interest rates as the NASDAQ fell, but instead waited until it saw signs of slackening investment growth. How could anyone in the aftermath of the NASDAQ crash could speak ... of the Fed as providing "free insurance for aggressive risk-taking"?

[There is confusion]... between the effects of (i) good, stabilizing monetary policy ..., and (ii) the "Greenspan Put" proper...

    Posted by on Thursday, August 2, 2007 at 03:06 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (7)

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