Stock picker Janet Yellen

If you are looking for a new stock broker look no further! This is Fed chair Janet Yellen at her testimony in the US Senate yesterday:

“Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”

This is quite unusual to say the least that the head of most powerful central bank in the world basically is telling investors what stocks to buy and sell.

Unfortunately it seems to part of a growing tendency among central bankers globally to be obsessing about “financial stability” and “bubbles”, while at the same time increasingly pushing their primary nominal targets in the background. In Sweden an obsession about household debt and property prices has caused the Riksbank to consistently undershot its inflation target. Should we now start to think that the Fed will introduce the valuation of biotech and social media stocks in its reaction function? Will the Fed tighten monetary policy if Facebook stock rises “too much”? What is Fed’s “price target” in Linkedin?

I believe this is part of a very unfortunate trend among central bankers around the world to talk about monetary policy in terms of “trade-offs”. As I have argued in a recent post in the 1970s inflation expectations became un-anchored exactly because central bankers refused to take responsibility for providing a nominal anchor and the excuse was that there are trade-offs in monetary policy – “yes, we can reduce inflation, but that will cause unemployment to increase”.

Today the excuse for not providing a nominal anchor is not unemployment, but rather the perceived risk of “bubbles” (apparently in biotech and social media stocks!)  The result is that inflation expectations again are becoming un-anchored – this time the result, however, is not excessively high inflation, but rather deflation. The impact on the economy is, however, the same as the failure to provide a nominal anchor will make the working of the price system less efficient and therefore cause a general welfare lose.

I am not arguing that there is not misallocation of credit and capital. I am just stating that it is not a task for central banks to deal with these problems. In think that moral hazard problems have grown significantly since 2008 – particularly in Europe. Therefore governments and international organisations like the EU and IMF need to reduce implicit and explicit guarantees and subsidies to (other) governments, banks and financial institutions to a minimum. And central banks should give up credit policies and focus 100% on monetary policy and on providing a nominal anchor for the economy and leave the price mechanism to allocate resources in the economy.

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  1. Did you notice that the pattern of Yellen´s dress was “bubbles”?

  2. brendan

     /  July 16, 2014

    A handful of stocks, composing one one-millionth of global asset value, appear bubbly. Policy options:
    a) make it easier to short these hard to short stocks (I’d be happy to partake)
    b) consider triggering a worldwide money-tightening spree.

    Here’s a webcomic idea for someone w/ computer skills. In one caption, Janet Yellen’s face photoshopped on Tom Cruise from minority report, in that room where Cruise rifles through hundreds of data feeds looking for crime to stop…Facebook’s P/E just hit 60!!! GO GO GO!!!!

    And in the other caption, a friggin TI-83 calculator adjusting the money supply as a function of changes in a NGDP futures market.

  3. Benjamin Cole

     /  July 17, 2014

    Excellent blogging.

  4. This is an interesting problem. On the one hand, I’ve been impressed with economists and central bankers becoming better at incorporating market data into their frameworks (possibly the effect of market monetarism!)… but on the other hand, it’s worrying if they refer to the wrong market indicators. Sadly there’s a long history of the latter! Are biotech and social media stocks the equivalent of oil in 2008?

  5. Why don’t central bankers give speeches about either (1) why they support NGDPLT or (2) why they don’t? Is it too much to ask? They give endless speeches about irrelevant topics, but when it comes to monetary theory, they act as though there is no debate (like left-wing politicians on the subject of global warming). The only guys out there who understand monetarism are Shinzo Abe and Hiroku Kuroda, and they don’t say much.

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