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Should the government peg the S&P 500?
The very well known macroeconomist Roger Farmer says yes:
It is time for a greatly increased role for monetary policy through direct intervention of central banks in world stock markets to prevent bubbles and crashes. Central banks control interest rates by buying and selling securities on the open market.
A logical extension of this idea is to pick an indexed basket of securities: one candidate in the US might be the S&P 500, and to control its price by buying and selling blocks of shares on the open market.
That is from the FT. Though he says he is warming to the idea, to my ear Mark Thoma sounds skeptical as am I. Public choice considerations aside, if the Dow is valued at 7000 in market opinion and the Treasury (Fed?) is propping it up at 8500, a lot of people will sell shares into the hands of the government. How much are the shares worth then? How hard will the government try to break the shorts who speculate on lower prices? Will this work any better than currency pegs? What are the implications for pursuing other monetary targets, such as the rate of inflation? If the peg succeeds who would hold other, riskier assets?
Some people might even say that the "Greenspan put" was part of what got us into this hole in the first place.
Farmer is working on a book How the Economy Works and How to Fix it When it Doesn’t.
Posted by Tyler Cowen on December 30, 2008 at 04:26 PM in Economics | Permalink
Comments
Do we really need to go back to high school economics and remind people that the stock market is an atrocious proxy for the economy? For starters, the stock market does not include government, small businesses, or most real estate.
Good grief.
Posted by: KipEsquire at Dec 30, 2008 4:38:25 PM
We all have silly ideas from time to time. The trouble with the Internet is that nowadays they quite often get into circulation.
Posted by: D iversity at Dec 30, 2008 4:41:56 PM
Worst idea ever. Yea a risk free index fund that makes 6%(or whatever) per year that wont screw things up.
Posted by: DRB at Dec 30, 2008 4:56:33 PM
It's a bit of a cheat, that article, since Farmer doesn't tell what the "right" P/E is for the S&P. Also, he doesn't tell us what the "right" cap rate is for commercial real estate, or the "right" credit spread for BBB corporates, or any of the things the government will need to figure out.
Posted by: y81 at Dec 30, 2008 5:01:01 PM
From time to time I flirt with economistphobia -- but mostly I resist it. "Ideas" such as this one makes it harder to reject it, however.
Posted by: Alex at Dec 30, 2008 5:07:37 PM
Now that the govt already bails out all the debt holders.. why not bail out the stock holders... only issue being.. now that the treasury becomes one big hedge fund who bails it out when it implodes... what say?
Posted by: SA at Dec 30, 2008 5:12:19 PM
In 1997, the Hong Kong government intervened to support the local stock market... and ended up making a tidy profit as the market recovered. It is far from clear, however, that the conditions are right for pulling this off in the US.
Posted by: at Dec 30, 2008 5:14:11 PM
Why would the government want to peg one group of assets? Would the government then be obligated to peg an index for housing, an index for agriculture commodities, an index for rare books, an index for Beanie Babies?
Once price as a signaling mechanism for any asset is destroyed, what regulates supply? the Central Committee?
Posted by: John Dewey at Dec 30, 2008 5:15:41 PM
I agree with John Dewey. Where does it end? If anything, I think the last six or so months have taught us that we need the pricing mechanism to work without interference,rather than with more of it.
Also, is anyone else frightened by the title of Farmer's book?
Posted by: MnM at Dec 30, 2008 5:31:09 PM
Price controls have always made more sense than wage controls. And, now that wage controls are meaningless ...
Posted by: ken melvin at Dec 30, 2008 5:35:40 PM
That's the stupidest thing I've ever heard.
On the other hand, it *does* make sense to pay attention to S&P appreciation as a proxy for financial wealth inflation -- something that can be countered with interest rates, not purchases.
Posted by: David Zetland at Dec 30, 2008 5:39:27 PM
if governments want to affect the price of some assets it seems like local governments should tear down and clean up abandoned houses. they could hire unemployed construction workers to clean up part of the urban blight and put some upward pressure on house values at the same time.
Posted by: paul at Dec 30, 2008 5:56:53 PM
Doesn't this confuse what the stock market is? This might almost make a bit of sense if the stock market dictated the health of the economy, but since stock prices merely reflect the health of the economy the only effect this would have is it would take away aggregate stock prices as a meaningful indicator of that health. However, if one's goal was to obfuscate normal indicators of national economic health so that one can fool the public into believing that the economy was honky dory as it fell apart around them, then this idea might work swimmingly.
Posted by: Carlton Smith at Dec 30, 2008 6:34:56 PM
It's better than gold, at least.
However, it means that if you hold dollars, you're really holding the S&P 500 index fund.
Bad news for S&P 500 index fund managers, too.
Posted by: rhhardin at Dec 30, 2008 6:36:10 PM
would someone please remove this academic from where he can do real harm.
may i suggest a stint studying migratory patterns or something?
sweet baby jeebus.....
Posted by: nullpointer at Dec 30, 2008 6:48:03 PM
Farmer should consider putting a question mark at the end of the title of his new book:
How the Economy Works and How to Fix it When it Doesn’t?
Posted by: tom at Dec 30, 2008 7:00:02 PM
Shoot me now and get it over with. The reason the market works is because there are short sellers.
With government only buying and not short selling, you'll see a version of the 1929 stock market.
Posted by: RM at Dec 30, 2008 7:07:40 PM
Now, color me skeptical, but wouldn't targeting the S&P 500 require a LOT more money than targeting the Fed Funds interest rate?
Posted by: Robert Olson at Dec 30, 2008 7:07:48 PM
Absolutely awful idea. Beyond bad. Better yet, we have a natural experiment to demonstrate just how bad such a strategy would be in execution: the Black Monday Crash of October 1987.
Here's a quick rundown of what happened. Looking to the future, investors anticipated that the expected growth rate of dividends would accelerate, then briefly stall out, then resume their higher level of acceleration shortly afterward.
In the months preceding the crash, investors had pushed up stock prices in anticipation of higher dividends being paid in future quarters (coinciding with an acceleration in the rate of growth of earnings). But then they ran into a chaotic time conflict. They looked past the coming dip in dividend levels and kept stock prices at their elevated level, focusing instead on the increasing rate of dividend growth that followed the dip. And why not? The dip in the acceleration of the growth rate of dividends would only last for a quarter before resuming its faster growth track.
That's where things really went wrong. Serious imbalances formed across the markets until stock prices could no longer be sustained at their higher level - the market crashed as it became clear that the growth rate of trailing year dividends per share in the fourth quarter of 1987 was going to be near zero.
More than that, that imbalance of forces helped push stock prices far below where they would have dropped had investors not tried to keep them suspended. Artificially, if you will.
Fortunately, the following acceleration of dividends ensured that the crash would be a short term event. The markets quickly recovered.
As a neat metaphor, the crash itself was a textbook example of cartoon physics - specifically, the kind of physics that are in play when Wile E. Coyote is chasing the Road Runner. Imagine Wile E. chasing the bird off one mesa toward another. They both run off the edge of the first mesa. The Road Runner never looks down and reaches the next mesa, but Wile E. looks down, and per the laws of cartoon physics, plummets to Earth. And also per the laws of cartoon physics, he doesn't stop when he hits the ground, but continues to make a deep coyote-shaped hole before bottoming out.
Somehow, I don't think the government is any smarter than Wile E. Coyote, nor would any strategy that defies the basic physics governing the stock market be successful.
Posted by: Ironman at Dec 30, 2008 7:20:14 PM
With Roger Farmer we now have a new definition for macroeconomics. "Macroeconomics is the art of looking for trouble, misdiagnosing it and misapplying the wrong remedies." (Thanks Groucho)
Posted by: tom at Dec 30, 2008 8:30:56 PM
What's wrong with the gold standard? It worked very well until the governments decided they wanted to start slaughtering each other's conscripts.
Posted by: Bob Murphy at Dec 30, 2008 8:46:34 PM
i think it's a fine idea, as long as the minimum could be set at 1913 levels.
Posted by: babar at Dec 30, 2008 8:48:11 PM
There have been a number of horrible ideas put forward recently. This beats them all hands down. How is the market supposed to allocate resources rationally if the government is setting the price of stocks?
Posted by: JP White at Dec 30, 2008 8:55:13 PM
Gold is a much better choice.
The total supply of gold changes extremely slowly. Almost all of the gold that has ever been mined is still part of this supply, so newly mined gold cannot change the total amount by very much at all.
The price of gold only appears to fluctuate. Its really the dollar that's changing. You can see the inflation that caused the housing bubble and the deflation caused by the collapse of that same bubble very clearly when you look at the price of gold:
http://tinyurl.com/10yeargold
Now demand for gold does fluctuate, its most volatile when currencies are being inflated willy nilly.
I really recommend reading Jude Wanniski's The Way the World Works if one wishes to understand how destructive inflation can be and why basing the value of currency on gold makes the most sense.
Posted by: Alan Brown at Dec 30, 2008 9:29:53 PM
If the growth in the amount of goods and services being exchanged outpaces the growth in the gold supply, then a gold standard is inherently deflationary.
Posted by: Cyrus at Dec 30, 2008 10:02:27 PM
