Alan Greenspan, the head of the US central bank, the
Federal Reserve, has warned that he must watch the
stock market more closely in order to control inflation.
In a speech to central bankers who have gathered at the
Fed's annual retreat at Jackson Hole, Wyoming, he said
that policy makers needed to understand better how the
booming stock market had affected people's economic
behaviour.
"Central bankers in particular
are going to have to ascertain
how changes in balance
sheets of economic actors
influence real economic
activity, and hence, affect
appropriate macroeconomic
policies," he said.
He believes that as more and
more people own substantial
financial assets, it could
become harder to predict
economic behaviour which
could be affected by sudden changes in stock prices.
"As the value of assets and liabilities have risen relative
to income, we have been confronted with the potential for
our economies to exhibit larger and perhaps more abrupt
responses to factors affecting the balance sheets of
households," he said.
Over-valued stocks?
Mr Greenspan has repeatedly warned that the stock
market is over-valued by historic measures, and most
recently he questioned investment in high-tech Internet
stocks.
The Fed is particularly concerned about the so-called
"wealth effect", where people feel better off because the
value of their shares have risen, and stop saving.
There have been negative savings rates in the United
States for the last year.
Mr Greenspan fears the effect of a sudden contraction in
the stock market, when panic spreads uncontrollably,
such as during the financial crisis last autumn.
"History tells us that sharp reversals in confidence
happen abruptly, most often with little advance notice .. if
episodic recurrences of ruptured confidence are integral
to the way our economy and financial markets work now
and in the future, it has significant implications for risk
management and .. macroeconomic policy," he said.
In effect, he was warning people to diversify their assets
before the next financial panic.
The US markets reacted negatively to Mr Greenspan's
remarks, with the index of leading stocks on the New
York Stock Exchange, the Dow Jones Industrial
Average, dropping 50 points on the news.
Cashing in on rising house prices
Mr Greenspan warned that borrowing against the
increased value of one's home was also on the increase
in the United States. He said that new Fed research
suggests that "extraction of equity from housing played
an important role" in increasing consumer spending.
Just as in Britain in the l980s, this could prove ultimately
unsustainable and highly inflationary. House prices are
not rising as fast in the US as they were in the UK,
however, but this phenomenon may explain why recent
interest rate hikes have failed to cool the housing boom.
The difficulty for Fed policy makers now, as it was for the
Bank of England then, is how to intervene in financial
markets so as to slow the boom without precipitating the
very panic they are trying to avoid.
This may explain the cautious way the Fed has raised
interest rates so far this year.
news.bbc.co.uk
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