The Dow is now above 17,000 and everyone seems to be asking the obvious question: Is it a bubble?
It might be surprising to hear that the chairwoman of the Federal Reserve thinks bubbles aren’t within her purview anyway.
This is a surprising shift in Fed logic. In the past, Fed chairs have simply denied the existence of bubbles until they are upon us. At which point they tend to throw up their hands and offer up hopelessly lame excuses.
Greenspan, for example ran back to his Ayn Randian roots and clung to his belief that markets would self-regulate, despite the obviousness of that not being true. Bernanke in turn simply played dumb and pretended he was unaware of the bubble, despite the fact that legions of critics, lowly bloggers, and non Fed-payroll economists had been screaming about it for years prior.
But Yellen’s speech to the IMF shows an approach which is new and somewhat jarring. Let’s call it: “What do you want us to do about it anyway?”
“Monetary policy faces significant limitations as a tool to promote financial stability: Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment.”
Pardon our French, but: Holy sh*t, Janet. Really?
If we may paraphrase: “We don’t really understand how to use monetary policy to pop bubbles. And it might be painful, anyway”.
So here we have the very definition of an irresponsible institution. They create bubbles under the banner of “creating stability” (this is merely a code-phrase for preserving the status-quo, but we’ll talk about that in another post), and yet by their own admission, they lack the capacity or the tools to stabilize the bubbles they have created.
As we have written before, financial crises are not defined by the downturns. Crises are defined by the inflationary phase when asset prices are rising, not by the eventual collapse. One cannot separate the former from the latter.
What Yellen is saying is that the Federal Reserve is not responsible for the collapse phase (or capable of initiating it in a controlled manner) — even though the Fed is directly responsible for inflating the bubble to begin with. If they do not understand how to use monetary policy to unwind bubbles, then by what logic should this institution be empowered to create them? What other organization is permitted to create problems of catastrophic proportions, and then point to them as if they are ‘acts of god’ and deny responsibility?
On the same subject: Here’s a great old Bloomberg clip with David Stockman for anyone who missed it. It’s a bit of an oldie but a goodie, and as true today as it was last year.