I read this excerpt from a speech by Ben Bernanke in September (courtesy of Cullen Roche):
The tools we have involve effecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other interest rates, corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand… if people feel their financial position is better… they’ll be more likely to spend, and that’s going to provide the demand firms need in order to be willing to hire and to invest.
It stopped me in my tracks. Here is why:
- The Fed Chairman avoids stating the obvious: there is only one aim of monetary policy: to increase or decrease the amount of debt in the economy. Their tools are designed to encourage people to borrow more — or occasionally less, when the results of their earlier policy materialize.
- Raising prices to increase demand? Raising home prices is unlikely to clear inventories of unsold homes or stimulate the construction industry.
- What Bernanke is referring to is known as the “wealth effect” — raising asset prices by lowering interest rates stimulates spending. The “wealth illusion” would be a more appropriate name.
- Rising asset prices make people more willing to spend. He is 100% correct here. But he fails to mention the resulting asset bubble that follows. Low interest rates and rising prices feed speculation….. which lead to higher prices and more speculation….. which lead to a self-reinforcing spiral.
Economics is not a hard science like engineering or physics, where one can accurately gauge outcomes. It is a soft science, like psychology, and many practitioners with competing theories as to how to treat the patient. With spectacular failure rates. Theory after theory is consigned to the waste basket as we struggle to understand the human condition.
You are absolutely right about the ‘wealth illusion’. As an economist, I am not even sure if economics is any kind of science without its quantitative tools, which are borrowed from mathematics and statistics. All the rest is subjective opinion based on observations that most often resemble those of a group of blind men trying to describe an elephant by touch. More and more, I am reminded of Arthur Clarke’s assertion that in the (distant) future, disciplines like economics and politics will cease to exist as these are not pursuits fit for adults.
I think the study of economics is important — so that we are aware how little we know.
Indeed. I chose it, didn’t I? Yet, as Bertrand Russell observed, fools and fanatics are so certain of themselves, but wiser people so full of doubts. The reason why Arthur Clarke spoke of politics and economics in the same breath is because they are two sides of the same coin. From the ancient Arthashastra of Kautilya (circa 350–283 BC) to Machiavelli’s Prince (1513), it has never been about economics as such, but rather about ‘political economics’, more often than not associated with wars. It wasn’t a coincidence Kautilya was teacher and guide to Chandragupta Maurya, legendary conqueror and founder of the Maurya empire in India. Nor was it an accident Machiavelli chose to provide ‘scientific’ rationale for the conquests of the colonial era that began around his time. Had I read them before I read Adam Smith, I might have stayed away and left things to Smith’s invisible hand.
yes agree with these comments…so why is Ben Benanke so blind. he even agrees with all the conclusions made by Fisher (I think thats his name) a leading economist repsonsible for policy at the time of the depression, but then overlays the caveat that human nature determines the overall outcome. Such madness..how does a man like this end up in this position.
Colin
I too agree with your assessment. And as an answer to Michael , he is there because the bank owners want him to be.
However it is all very well agreeing with each other, but we need to have some alternative’s to this madness.if there is any hope for change. .
Chris, You seem to be forgetting that he is appointed by the government, not by the banks. The banks appoint the government 🙂
Indeed. I chose it, didn’t I? Yet, as Bertrand Russell observed, fools and fanatics are so certain of themselves, but wiser people so full of doubts. The reason why Arthur Clarke spoke of politics and economics in the same breath is because they are two sides of the same coin. From the ancient Arthashastra of Kautilya (circa 350–283 BC) to Machiavelli’s Prince (1513), it has never been about economics as such, but rather about ‘political economics’, more often than not associated with wars. It wasn’t a coincidence Kautilya was teacher and guide to Chandragupta Maurya, legendary conqueror and founder of the Maurya empire in India. Nor was it an accident Machiavelli chose to provide ‘scientific’ rationale for the conquests of the colonial era that began around his time. Had I read them before I read Adam Smith, I might have stayed away and left things to Smith’s invisible hand.