Another way of saying velocity is declining is that there is
an increase in money demand. The Fed can of course accomodate
such an increase, at least in the short-run, without causing
interest rates to fall and overstimulating the economy. But in
a model where it's not just the real economy, but also the
financial sector, that's involved, a stock market bubble will
presumably cause an increase in money demand as well, and by
accomodating that, you "enable" the bubble. But using monetary
policy to damp the bubble would clearly have undesirable contractionary effects on the real economy, so you don't want
to do it lightly, and especially not if there isn't really a bubble.
What we might hope a serious economist on this thread might address
is, would it even work very well? I.e., work short of inducing
a huge recession, cutting corporate profits so that the market looks
clearly overvalued? Would the portfolio effect of higher interest
rates causing a shift out of equities work faster than the rates
hit the real economy too badly? Perhaps... but in this market they
might at first just cause yet more dollar appreciation, inflows of foreign
money into our bonds *and* to some extent equities as well...
Of course I think you are right, Zeev, that much of the increase
in demand is not for financial transactions within the US but for
socking away under mattresses in Asia (and Los Angeles, although
the mattresses are in banks) and elsewhere, serving as currency in
some parts of the world, etc... If and when *that* money demand
drops, the question is: can the Fed respond appropriately to
counteract that shift. With both open market operations and
foreign reserves at their disposal, they're well equipped.
I haven't addressed Lawrence Kam's points, because of "2)":
I dont' understand the finer points of his argument; maybe
when I do, I will. Obviously, it's extremely important to
try to figure out, empirically, whether the money's pumping
up financial markets, or going into third world mattresses.
Or going into third world big shots LA bank accounts and being
recycled to pump up financial markets -g-.
Just some things to think about... maybe we can get Paul Krugman
and Rudiger Dornnusch to visit the thread and comment :-).
They're just across the river from Mr. Kam, no?
Cheers,
HB |
