Raising the Bar

Brad De Long delong at econ.Berkeley.EDU
Fri Sep 4 06:31:29 PDT 1998

>DICKENS, EDWIN (973)-408-3024 wrote:
>> Max,
>> Your policy of spending the surplus can
>> "help people...spend even more, yum, yum)"
>> without using a temporary interest rate cut to bail out hedge funds and
>> the banks etc. that financed them, no? Why socialize Wall Street's
>> losses?
>> Edwin Dickens
>Max, I don't see lowering rates either. In addition to "why bail out
>the speculators?", wouldn't lowering rates make it easier for the
>speculators to continue their game, getting us ever closer to a
>real meltdown?

The fear is that the flow of finance *through* Wall Street--from investors through financial intermediaries and then out the other side in the form of capital available to businesses to boost their capacity--is about to come to a screeching halt.

The idea is that reductions in interest rates will make firms more willing to continue to invest to boost their capacity--that if they can't get their capital from Wall Street via IPOs (and so forth), they can get their capital from banks making low interest-rate loans.

The task--as at least Larry Meyer and Alice Rivlin on the Federal Reserve Board see it: I don't know Greenspan's thought in any detail--is to make sure that as the stock market declines businesses continue to be able to raise capital on attractive terms to keep investment relatively high, and thus aggregate demand relavitly high and unemployment relatively low.

The questions is when and how far. On the one hand, the stock market has fallen 15% from its highs. On the other hand, Robert Shiller's work suggests that it still some 35% too high (relative to historical average pricing patterns). On the third hand, short-term interest rates on safe assets are now at inflation + 3.5%, when historical average pricing patterns suggest that they ought to be more in the 1.5 - 2.0% above inflation range.

Complicating things even more is that Federal Reserve action taken next month affects investmen and employment in the winter of 2000: so the Federal Reserve is making its decisions not on the basis of the state of the economy now but on its guesses of what the state of the economy will be in fifteen months...

Brad DeLong

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