January 12, 2006
IN SEARCH OF CLARITY (AGAIN)
Does he or doesn't he think asset prices are crucial for setting monetary policy? One could be excused for having a less-than-clear grasp of the answer after digesting the talk dispatched by New York Fed President Timothy Geithner yesterday at the New York Association for Business Economics in Manhattan. Throughout his speech he alternatively endorsed and distanced himself from the value of asset prices as practical tool in the setting of interest rates.
Yet even though the man on the street would recognize Geithner's commentary as an instance of flip-flopping, it's also true that relative to the Fed establishment he's taken a relatively clear course in elevating asset pricing as something more than intellectual garbage in monetary theory. Such is the state of central banking these days in America where any and all viewpoints are at once embraced and discarded.
At the start, at least, he set a tone that seemed intent on drawing hard and fast rules. Alas, it proved a fleeting moment. "As financial markets continue to broaden and deepen," Geithner advised, "the behavior of asset prices will play an important role in the formulation of monetary policy going forward, perhaps a more important role than in the past."
Just what "important" means has yet to be determined, although one could assume it would translate into asset prices casting a greater influence on the direction and level of interest rates going forward compared with the past. But presumptions may be dangerous, based on the subsequent qualifications Geithner laid out in his talk.
Indeed, there are many assets to consider in the global economy, and gold is one of them, though not necessarily a favored one in central banking courtesy of the precious metal's tendency to take flight these days. Gold closed just below the $550 level yesterday, up around 6% so far this year, and after a stellar performance in 2005. The buying continued this morning, with gold barreling above that round number.
Perhaps goldbugs are simply underscoring another of Geithner's comments from yesterday's chat, when he observed a "relatively low compensation for risk priced into asset markets today…." Might he be referring to the 10-year Treasury yield, which remains under 4.5%, or roughly a spare 100 basis points over the government's estimate of annualized consumer inflation as of November?
Lest any one think Geithner is about to start advising Ben Bernanke (the Fed chairman in waiting) on the merits of gold, or any other asset as a foundation for a new era of monetary pricing, think again. "There is a well established, and I believe fundamentally correct, case against directing monetary policy at specific objectives for asset values or the future path of those values," he explained. "In other words, asset values should be neither a target nor a goal of monetary policy. The rate of increase in asset values alone seems to tell us very little about underlying and future inflation."
Really? Gold is of no value in assessing inflationary pressures? How about real estate, or oil, or a broad basket of commodities, stocks and bonds? Alas, no, in the mind of Geithner. "Because we know so little about how to assess the appropriateness of asset values against fundamentals," he continued, "because we have so little capacity to both forecast and predictably affect the future path of asset prices, and because we know relatively little about how changes in wealth affect the real economy and inflation, we cannot use monetary policy responsibly or effectively to achieve specific objectives for asset values."
If asset prices are destined to have an uncertain authority in monetary policy, might the process work any difference in reverse? That is, does Geithner think the Fed can influence asset prices through the lever of fiat money? Not a chance, he opined, thereby reaffirming the company line in the legendary debate from a few years back as to whether Greenspan's Fed could have/should have pricked the stock market bubble in the late-1990s before it reached epic levels and then crashed. Setting out his thinking in no uncertain terms in this case, Geithner lowered the rhetorical boom: "Monetary policy does not today and is unlikely in the future to offer us an effective tool for directly reducing the incidence of large or sustained deviations of asset values from what might turn out to be their fundamental values, what some call bubbles."
But just when you thought the asset price topic was inured against change in central banking, Geithner reversed course again, reasoning that "monetary policy still has to take into account the impact of significant movements in asset values on output and inflation. Financial asset prices, by their nature, allocate resources between the present and the future and thereby affect consumption, investment and future growth. History provides us with numerous examples in which significant movements in asset prices have had sizable effects on the path of output relative to potential and on price stability."
In fact, no matter whether you love or hate the link between asset prices and monetary policy, it's there and it's not going away. Geithner said as much, noting that "experience suggests that asset values can be very sensitive to movements in monetary policy or to the perceptions of future policy moves."
So, what should an enlightened Fed do? "The challenge for central banks, Geithner outlined, "is to determine how movements in asset values and expected asset values affect the evolution of the economy. There is little to suggest that the task has gotten easier with the increasing complexity of financial markets, and it has more likely gotten harder."
That sounds like an entry to declaring that the Fed should incorporate asset prices, tough as it is, into the monetary policy mix. But it wasn't, as his concluding remarks attest. The future, in short, remains unclear as to how the Fed will pursue monetary policy in the new era set to launch with the assumption of the throne by Ben Bernanke at the end of the month.
So, what else is new? Nothing, really. That is, unless your time horizon is measured in years as opposed to days. Don Luskin, chief investment officer of TrendMacrolytics, laments the fact that in the good old days the central bank would be responsive to the raging bull market in gold of late. "Gold, now at new recovery highs and 60% above its 10-year moving average, is expressing inflationary expectations in relation to the existing price level that have historically been associated with a 5.5% core CPI, based on robust regression analysis," Luskin writes in a note to clients sent yesterday. "There was a time more than a decade ago when Alan Greenspan, as well as Fed governors Wayne Angell and Manuel Johnson, would have been very responsive to such an alert -- but those days are gone."
Geithner seems inclined to agree. In his concluding remarks yesterday, the New York Fed chief offered something less than complete clarity on what the central bank might do in regards to incorporating asset prices into the policy mix: "Asset prices probably matter more than they once did, but what that means for monetary policy necessarily depends on the circumstances."
Perhaps the incoming Fed chairman will have a different perspective. As such, Mr. Bernanke, the proverbial ball is now in your court.
Posted by jp at January 12, 2006 10:25 AM
It all begs the question why have a Fed? If it is so tricky for a central body to tinker with rates and guess the consequences why dont they get out of the way and let Mr Market determine rates as they do across the rest of the curve (although foreign central bank intervention buggers that up as well)...
Posted by: Jonathan at January 13, 2006 2:47 AM