On markets and helicopters
- 6 March 2013
- From the section Business
Stock markets have continued to take off in recent weeks. The UK and US markets are now back where they were before the 2008 crisis, having risen more than 9% since the start of the year.
Clearly, investors aren't taking their cues from the real economy, at least in the UK. Nor do they seem to paying much attention to governments. But are they expecting too much from the world's central banks?
As I mentioned on the television news last night, the record level of the Dow Jones industrial index, and the very close-to-record level of the much more important S&P 500 index, are partly a reflection of the good news that has been coming out of the US economy - at least the privately owned part of it.
You can't say the public side of things looks very attractive right now, as President Obama and the Republican leadership in Washington continue to argue about the Budget.
But if investors are ignoring the politicians, for the time being, they are definitely not ignoring the central bankers.
In fact, it's almost certainly the signals coming out of the world's central banks that have done most to send stock markets up this year.
In their different ways, the US Federal Reserve, the Bank of England and the Bank of Japan have all made clear that will continue to offer massive support for the economy in the form of cheap money - even if and when the recovery finally starts to gather some steam.
In other words, there will continue to be a lot of money sloshing about the world, looking for a home. And investors are betting that home will be financial assets.
Janet Yellen, vice-chair of the US central bank and the person many expect to succeed Ben Bernanke, is the latest senior figure to contribute to this trend, in a speech earlier this week.
The message of her speech was that the Fed would continue spending money for some time to come.
There's been more "noise" in recent debates about the Bank of England's policy, with all the talk about nominal income targeting, negative interest rates, and other radical steps.
But you can't help noticing that all of that discussion has been about new and exciting ways to stimulate the economy.
There has not been much discussion about new ways to tighten. Indeed, many in the City think the Monetary Policy Committee might vote for more quantitative easing as early as tomorrow.
Sushil Wadhwani, a former member of the Monetary Policy Committee and distinguished economist, made his own contribution to that debate in a lecture last night. I recommend you read it, for the excellent charts alone.
He makes an interesting argument, pointing out how the connection between loose monetary policy and stock markets has changed in the last decade or so.
In the 1970s and 1980s, stock prices fell when inflation expectations went up.
That is one reason why academics and policy makers thought central bank efforts to cut inflation would stimulate growth, and a failure to control inflation would always hurt it.
But now we are in a very low interest rate, potentially deflationary world, Wadhwani says the relationship now works the other way.
If central bankers push up expectations of future inflation, that now seems likely to push the stock market up.
Why? You need to read the speech for the full explanation, but the basic idea is that higher inflation can help push down the real cost of borrowing - the real interest rate - at times when nominal interest rates can't go any lower.
What does that mean for real-life policy making?
Well, Sir Mervyn King will be relieved to hear that Wadhwani does not like the idea of targeting nominal GDP - the cash value of the economy - instead of inflation.
Like Sir Mervyn, he thinks it's not flexible enough and risks tying the central bank's hands.
But Sir Mervyn will not like where the speech goes next. Wadhwani thinks the best thing that the central bank could do to stimulate the economy would be to print money to fund a one-off fiscal stimulus, sending a voucher to every household in the country, which they could spend however they wished.
This is our old friend, "helicopter money", which Wadhwani believes could help boost economic activity without causing serious problems for inflation. (In fact, he first proposed this with another economist Michael Dicks in 2011).
If you wanted to focus on investment, rather than consumption, he adds you could use the money to fund generous new investment allowances for UK businesses, instead.
There are lots of possible objections to this, some of which I've debated before (see, for example, Should Bank start the helicopter?). Wadhwani has some interesting answers, which I hope to return to another time.
The larger point is that there is now a surprisingly long list of respected figures who have said a "helicopter drop" - a dose of money-financed fiscal stimulus which is never paid back - is worth talking about, even if they do not necessarily want to do it right away.
Adair Turner is one example. Willem Buiter is another. Ben Bernanke himself spoke about it in 2002.
Wadhwani himself has thought about the scheme in enough detail to conclude that it would be "desirable if the Chancellor of the Exchequer himself would sign the vouchers".
I can't help thinking that is unlikely. (He could always get Ed Balls to sign them, to hedge his bets.)
Wherever the debate ends up, you can see why people in the City would be expecting the cheap money era to continue in the UK for a long time to come. But sooner or later, the rise in equity prices will need to be matched by rising corporate earnings.
About two-thirds of the earnings of the companies in the FTSE come from outside the UK.
The sad reality is that most of the world - certainly outside Europe - is growing a lot faster than the UK. But sooner or later we do need the real economy to start to catch up with all these enthusiastic investors.
Otherwise those stock prices might very well come back down to earth.