At the core of Market Monetarist thinking is the view that financial markets are incredibly important indicators of monetary policy conditions. That idea is certainly not new. Just take a look at this article from April 28 1938 (reproduced from the Australian newspaper The Courier Mail):
STOCK EXCHANGE AS BAROMETER
Professor Gustav Cassel, of Sweden, states that the Stock Exchange has often been represented as an astonishingly sensitive barometer, which indicates beforehand what is going to happen in economic life.
Recent experience, however, forced the conclusion that the economic recession in 1937 was in a marked degree, the effect of the distrust shown by the Stock Exchange, and thus might have been avoided if the Stock Exchange had not been exposed to the serious disturbance of confidence which a vacillating monetary policy is always bound to entail.
The ability of the stock exchange to fulfil its functions and to make a firm resistance to a panicky pessimism was greatly impaired by a number of restrictive measures, which, even if they had a grain of justification; unfortunately were framed under the influence of dilettante ideas about the stock exchange as the root of all evil.
There we have it – Gustav Cassel was a Market Monetarist or rather Gustav Cassel is a great influence on Market Monetarist thinking even when we don’t realise it.
The following sentence is especially notable: “the effect of the distrust shown by the Stock Exchange, and thus might have been avoided if the Stock Exchange had not been exposed to the serious disturbance of confidence which a vacillating monetary policy is always bound to entail.”
It is not the drop in the stock market that is causing the crisis, but rather the failure of monetary policy that is at the root of the crisis. The stock market, however, is a strong indicator of monetary policy failure. The quote also clearly shows that Cassel understood well the forward-looking nature of markets and the importance of monetary policy guidance. The stock markets crash in 1937 because policy makers signaled that monetary policy would be tightened (and was indeed tightened) and not because investors panicked. For more on the 1937 see my previous post: Remember the mistakes of 1937? A lesson for today’s policy makers
Hence, the stock market remains a great “barometer” of monetary policy. That was the case in 1937 – as is it today. The graph below – which I have used in an earlier post – illustrates this point quite well I think.
At the moment the “barometer” is pretty clear in its verdict – stocks are going up and that is a pretty clear indication that monetary conditions are getting easier.
The upturn in the global markets since August-September last year of course has coincided with Mario Draghi’s “promise” to do “whatever it takes to save the euro”, the introduction of the Bernanke-Evans rule by the fed, Prime Minister Abe in Japan forcing Bank of Japan to seriously step up monetary easing and finally the hope the the Bank of England under the leadership of Mark Carney will introduce some form of NGDP targeting.
Gustav Cassel would have approved.
And more on Gustav Cassel:
Gustav Cassel on Hoover’s Mistake and monetary policy failure
Gustav Cassel foresaw the Great Depression
Hawtrey, Cassel and Glasner
Gustav Cassel on recessions
Danish and Norwegian monetary policy failure in 1920s – lessons for today
“Our Monetary ills Laid to Puritanism”
Calvinist economics – the sin of our times
France caused the Great Depression – who caused the Great Recession?
Update: Felix Salmon has a some different blog post, but it is nonetheless related.