August 13, 2002
Fed Admits Defeat
That the Fed did nothing to stop the bull market of the late 1990s and is blaming the demise of the bull for today’s economic woe speaks volumes.
By Brady Willett


The popular logic, which has yet to be proven, is that for every dollar in stock market wealth that is created roughly 5-10 cents in added consumer spending materializes.  However, through out the latter part of the 1990s Federal Chairman Greenspan was reluctant to refer to the ‘wealth effect’ in deterministic terms: meaning that when he did mention the wealth effect at all he argued that it was largely immeasurable and not entirely responsible for a strong U.S. economy.

With this in mind, today’s Fed statement may be taken as an admission of guilt.  To be sure, Greenspan has long lamented both the ‘wealth-effect’ and ‘bubbles’ but has also concluded, on numerous occasions, that reversals in confidence and prices arrive “with little advance notice.” Point being, Greenspan and the Fed missed, by a long shot, calling the stock market a bubble and this is the reason why monetary policy has turned into a guessing game today. For certain, the Fed is guessing that a soft economy has emerged because of ‘weakness in financial markets and heightened uncertainty related to problems in corporate reporting and governance.’ After all, if the Fed didn’t know what was going on yesterday why should we believe that they know what is happening today? 

In sum, the Fed has officially admitted that it doesn’t control the financial markets and it cannot endlessly tweak interest rates and the stock of money to control demand. The U.S. economy is crying and the Fed, which everyone thinks has the power to cheer the economy up, has nothing to offer but a tissue and some contradictory viewpoints of what went wrong…

*One of Greenspan’s finest speeches (he asked all the right questions but, apparently, he didn’t have any of the answers).

New challenges for monetary policy
August 27, 1999
History tells us that sharp reversals in confidence happen abruptly, most often with little advance notice. These reversals can be self-reinforcing processes that can compress sizable adjustments into a very short time period. Panic market reactions are characterized by dramatic shifts in behavior to minimize short-term losses. Claims on far-distant future values are discounted to insignificance. What is so intriguing is that this type of behavior has characterized human interaction with little appreciable difference over the generations. Whether Dutch tulip bulbs or Russian equities, the market price patterns remain much the same.

We can readily describe this process, but, to date, economists have been unable to anticipate sharp reversals in confidence. Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. To anticipate a bubble about to burst requires the forecast of a plunge in the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific companies that make up our broad stock price indexes.

http://www.federalreserve.gov/boarddocs/speeches/1999/19990827.htm

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