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Monday, May 14, 2007



all the more reason why targetting inflation with an interest rate when you are running a large trade deficit, or surplus, is inane.

Arthur Eckart

The Fed has gone one step further. It has responded to potential trends. Consequently, U.S. monetary policy has been too restrictive. The Fed is willing to accept slower domestic growth to offset, and perhaps preempt, the domestic effect of a potential foreign negative shock. The ultimate goal of the Fed is to raise domestic living standards at the optimal rate, which is more important than the domestic goal of sustainable output through price stability. Obviously, the Fed has been most successful in raising domestic living standards.

AE: It (the Fed) has responded to potential trends.

You mean, of course, deflating the dot.com bubble that burst in 2000 before it ruined the life savings of millions of shareholders.

Yeah, right ...

Arthur Eckart

Lafayette, it's more accurate to say the Fed responds to major potential trends that it has the power to influence. The only way the Fed could have stopped the tech bubble was to create a recession. Also, I disagree the "dot.com bubble" "ruined the life savings of millions of shareholders." It generated a great deal of wealth, and reflected successful Fed policies (similar to more recent "bubbles," in the bond market, stock market, commodities market, housing market, etc.). The stock market crash of 2000-02 was a correcting mechanism to keep future labor supply and demand in equilibrium, because everyone cannot retire early. Nonetheless, even at the bottom of the crash, Nasdaq was four times higher than the early-'90s (i.e. recession or market trough in 1990 or 1991 to recession or market trough in 2001 or 2002).

AE: Nonetheless, even at the bottom of the crash, Nasdaq was four times higher than the early-'90s

Said like a true clinician, seemingly logical and utterly irrelevant.

What kind of response is this above? The Nasdaq was also 10 times higher than in the early-80s. So what, it's irrelevant.

People lost money in the market and those who bought in the sharp rise in late 1990 just before the bust in early 2000 have waited seven years to recover. There were many who piled in at the last minute, because they foolishly thought the stock market printed money.

If you feel the Fed should have done nothing about equity asset pricing, then certainly you feel the Fed should nothing about the real estate bubble either.

Some people buzz down the highway of life in a Ferrari and others are left as road kill. Simple world, yours.

Arthur Eckart

Lafayette, your implication that Nasdaq rose from 300 in 1991 to 5,000 in 2000, fell to 1,100 in 2002, and then rose to 2,500 in 2007 generally made people poorer doesn't make sense. The data don't support your belief, including the fact that for every seller (of stock) there's a buyer. The Fed doesn't care about individual markets, except how they affect the general economy. Obviously, the Fed has an excellent track record of smoothing-out business cycles, to optimize growth. The Fed targets the general price level of goods & services rather than asset prices, which are residuals. Your "bubbles" haven't affected the general economy much. You should praise the Fed's wisdom, ability, and performance to raise domestic living standards.

AE: The data don't support your belief

The Nasdaq run-up that created moist of the bubble is shown in this http://en.wikipedia.org/wiki/Image:Nasdaq_Composite_dot-com_bubble.svg>graphic of the Nasdaq index.

Just before the end of 2000, the Nasdaq was behaving in a orderly fashion with somewhat higher than normal appreciation in prices. However between September and January, people unwittingly piled into the technology market, creating the spike.

At that time, the conventional wisdom from Wall Street was, “The market is long-term. Keep your position and inevitably you will make money”. Unfortunately, they did not count on a bubble that was financed by millions who were betting on a freak acceleration in equity pricing defying all logic in the market.

As the graphic shows, the inevitable nadir was reached three years later, in the latter half of 2003. Prices bottomed, but till then anyone who had bought after Spring of 1997, three years before lost his shirt if he sold then. Many had been selling all the way down, and most were those who had jumped onto the rocket-powered bandwagon in the latter half of 2003.

Anyone who purchased after mid-1999 is just about to recover their losses some eight years later.

Cooler heads would have dampened the frenzy by restraining the ability to buy stocks on credit. The real estate bubble in the US is based upon the same erroneous reasoning.

Back to our debate, about the Fed. If the Fed’s primary responsibility is to control inflation, why did it not intervene when equity assets were hyper-inflating in 2000? Or more recently in the realty asset inflation?

Arthur Eckart

Lafayette, the stock market is the sum of all stock investors. If the stock market rises 1,000%, then the average investor made 1,000% (excluding commissions, taxes, etc.). I've shown evidence before that it's unlikely a general housing bubble exists. Obviously, the Fed did control inflation. It lowered the Fed Funds Rate to 1% in the early-2000s, after 20-years of disinflation, to avoid a liquidity trap.

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