Fed Action Likely if Stock Prices Keep Rising Faster Than Wages
By JACOB M. SCHLESINGER
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Has Alan Greenspan set a limit on how quickly the
stock market can rise?
In testimony before Congress last week, the Federal Reserve chairman
seemed to do so. The U.S. economy is unlikely to slow to what Mr.
Greenspan considers an appropriate pace, he suggested, unless "asset
values ... will increase no faster than household income." Taken literally,
that would mean stock prices should now grow at the relatively pokey rate
of about 6% a year, rather than the zippy 10% to 20% annual gains of the
late 1990s.
Yet Mr. Greenspan's intent is more nuanced than that.
The Fed isn't on autopilot, programmed to
jack up interest rates each time the Dow Jones
Industrial Average jumps more than wages.
Mr. Greenspan made sure to say that his
equation applies only if "other things [remain]
equal." He would be less inclined to curb the
stock market if exports fell, as happened
during the Asia crisis, or if the red-hot housing
sector cools, as many experts now expect.
Still, the Fed has asserted with new specificity
a stock-market pace that the central bank
considers desirable. The logic: The unprecedented surge in stocks is
making Americans feel a lot richer than they would based solely on
take-home pay, fueling consumption beyond the economy's apparent
capacity to meet such demand.
Increasingly Important Variable
It is important to understand what Mr. Greenspan isn't saying. He steers
clear these days of voicing his opinion on whether the stock market is
overvalued per se and has ruled out moving to try to pop a bubble. The
Fed's primary target in setting interest rates remains inflation. But the stock
market's growth is an increasingly important variable in models the Fed
uses to forecast whether inflationary pressures are building. A stock
market rising faster than household income makes Fed action more likely,
if not inevitable.
On Friday, the Dow Jones Industrial
Average dropped nearly 300 points
to 10219.52 on investor jitters that
the Fed will raise interest rates until
the economy slows -- and that won't
occur until the stock market cools to
the point where consumers spend
less.
In asserting a link between the stock
market and income, Mr. Greenspan
appears to be plowing new
theoretical ground. The formula isn't
commonly found in economic
textbooks and draws skepticism
from some prominent experts.
"I can't think of anyone who says the stock market does or should track
household income," says Yale University's Robert Shiller, an economist
who studies stock-market trends.
Sharp Divergence
History offers no clear guidance on whether such an assertion makes
sense, since the two indicators have never before diverged so sharply for
so long. For nearly half a century after World War II, household
wealth-stock values, as well as housing values, bank accounts and other
assets-rose roughly in line with after-tax incomes, defined as wages,
salaries, dividends and interest.
From 1946 through 1995, the ratio of household wealth to income mainly
fluctuated between a narrow band, with wealth ranging from 4.5 to 5.1
times greater than income. In only three years during that period did wealth
rise above that level, and never for two years in a row. Then in 1996, the
wealth of American households reached a postwar high of 5.31 times
income earned that year. The figure rose sharply again in each of the next
three years, soaring to 6.27 in 1999.
There is little question that is fueling demand. The Fed estimates consumers
spend three or four cents out of every new dollar of wealth.
Macroeconomic Advisers, a St. Louis forecasting company, estimates that
every percentage point of new stock-market wealth now generates twice
as much consumer spending as an equivalent increase would have five
years ago.
But why, specifically, should wealth grow no faster than income?
By the Fed's logic, consumer spending dictated by earned income is
basically OK, but stock-driven consumption is dicey. Income -- wages or
dividends -- is paid out of the revenue derived from current production.
Consumers relying on those payouts only have enough money to buy
goods already produced. Stock-generated wealth, however, is driven by
assumptions about future production, which could push current demand
above current supply.
"If wealth grows up in the same proportion as income, then everything
works out properly," says Jeremy Siegel, a finance professor at the
University of Pennsylvania's Wharton School. "Stock-market wealth
makes people feel rich and start spending, even though the production isn't
there yet," he adds. |
