Produccion En Investigacion Sobre Marketing 2003-2018

Theoretical models and their empirical applications suggest that even though it is widely accepted that asset prices offer (even partially) useful information to monetary policymakers in the short-term, views are mixed about whether they bear any strong link to the primary indicators of monetary policy (output gaps and inflation forecasts). Policymakers need to utilise a vast amount of, at times, conflicting information and imprecise indicators. In addition, they need to take real- time decisions regarding prospective economic growth and prices, without the benefit of hindsight.

Borio and Lowe (2003) examine the annual asset-price movements in 34 countries beginning in 1962, looking at 38 crisis episodes, only using data that available ex ante. They form an index of imbalances based on a credit gap (defined as credit growth deviations from trend), an equity price gap, and an output gap aiming in identifying incipient declines in asset prices, which may create significant real output losses. They argue in favour of the use of such an index as a guide for proactive monetary policy action. A similar index is used for the US during the 1920s by Eichengreen and Mitchener (2003), who show that it provides explanations of the severity of the Great Depression.

The analysis of Borio and Lowe (2003) justifies the presence of two completed asset price cycles since the 1970s. They, thus, extract two main results, namely, first, that asset-price and credit cycles often progress concurrently, and, second, that cycles seem to increase in magnitude. They contend that low inflation generates optimism about the economic environment which may further inflate asset prices in response to

an increase in productivity growth than will normally be the case. Equally, an increase in demand increases the likelihood of a rise in asset prices, in the case of a central bank being credibly committed to price stability. They argue that a credible commitment to price stability, in the short-run, renders product prices less sensitive to an increase in demand, the opposite holding for output and profits, while the absence of inflation may influence monetary policymakers to delay restricting monetary policy as demand pressures build. They reach the conclusion that asset prices provide useful information and that individual as well as aggregate asset prices should be used as a tool for conducting monetary policy.

According to Filardo (2003), however, the suggestions in Borio and Lowe (2003) that a “leaning-against-the-wind” approach to policymaking may be the best policy, need further empirical research into robustness of their policy recommendations under alternative economic environments161. Filardo (2003), stresses that McGrattan and Prescott (2003) give an interpretation of 1929 which should be a cautionary tale for any monetary policy approach that stresses a “lean-against-the-wind” policy during a run-up in asset prices. In particular, McGrattan and Prescott (2003) propose a measure of capital stock and compare it to market capitalization in order to identify if an asset-price bubble is present. Using this measure, they conclude that during 1929 the U.S. stock-market was, in fact, undervalued and that an asset-price bubble was not present. They argue that the subsequent stock-market crash was a result of the severely tightening monetary policy, but not the unwinding of a bubble.

161

However, according to Filardo (2003) Borio and Lowe (2003) “paint a picture of a very risky policy environment where financial instability is omnipresent and a natural consequence of economic success” and he recognises that this view reflects a long tradition in macroeconomics, as e.g. in Minsky (1982), (Filardo (2003), p. 295).

In addition, Filardo (2003) suggests that further investigation into bank regulation may uncover some unintended adverse consequences of some of the policy recommendations given by Borio and Lowe (2003). For example, the authors offer a recommendation that regulators use tighter capital standards during an expansion in order to restrain unwarranted optimism. However, in such a situation, Filardo (2003) argues that financial funds would flow out of the regulated banking sector into the relatively unregulated nonblank financial markets. Not only would this artificially reduce the beneficial role that banks play in the provision of loanable funds, but it would also boost the size of the unregulated nonblank financial sector, which would presumably fuel further unwarranted optimism and asset price appreciation. Hence, according to Filardo (2003) in this case, a “leaning against the wind” policy may have the opposite effect on financial stability than policymakers would expect (Filardo (2003), p. 295-296).

Detken and Smets (2004) study financial, real and monetary policy developments during asset price booms examining 38 boom periods in 18 OECD countries since the 1970s. Their results reinforce the findings of Borio and Lowe (2003) referring to the build-up of large real, financial and monetary imbalances, which may constitute a good indicator of potential financial and macroeconomic instability162. However,

162

They find that “real GDP growth is particularly strong during the boom, which is mainly driven by total private investment and is also reflected in housing investment, in both cases both in terms of growth rates as well as gaps (i.e. deviations of the investment ratios to GDP from estimated stochastic trends), and … monetary policy is looser during boom periods than in normal times as is revealed by deviations from the Taylor rule, as well as money and credit conditions” (Detken and Smets (2004), p. 31). In addition considering all booms, they find that in the boom phase inflation rates do not move substantially, despite rises in deviations from trend. They also find that those booms that preceded large recessions or even financial instability, tend to last longer and experience substantially greater real and monetary imbalances; they also tend to be characterised by a large boom and bust in the real- estate market. Finally, they find that cases of ‘high-cost booms’ also present a relatively more positive inflation gap, namely greater deviation of inflation from its trend, after the boom, despite the large fall in investment and output.

they do not provide an answer to whether ‘pre-emptive’ monetary policy tightening may be successful in preventing or alleviating subsequent asset price collapses without imposing a considerably high cost.

Furthermore, Bryan, Cecchetti, and O’Sullivan (2003) argue that asset prices offer useful information for monetary policymakers and that the latter should avoid using measures of inflation that focus only on the current cost of current consumption. They mainly underline the importance of inter-temporal analysis, argue against policymakers’ relying to a great extent on current consumer price index prices, and point out the challenging task of capturing the changing prices of non-financial assets. Bryan, Cecchetti, and O’Sullivan (2003) point out that in periods of real interest rate fluctuations, price information may be biased.

The key policy implication of Bryan, Cecchetti and O’Sullivan (2003) is that their new measure of inflation is higher than CPI inflation in the late 1990s, reflecting the rapid increase in asset price inflation. If the increase in asset prices was due to higher expected goods prices, then their method would lead the monetary authority tighten monetary policy and reduce the inflationary pressures. If, however, the increase in asset prices was due to an asset price bubble, then the Bryan, Cecchetti, and O’Sullivan (2003) method would generate an upward bias in their cost of life inflation measure and cause the monetary authority to pursue an unnecessarily tighter monetary policy, which could have scuttled the expansion and deepened the 2001 recession163 (Filardo (2003), p. 292).

163

Filardo (2003) makes the association with Alchian and Klein (1973), and identifies that the problem then, similar to the one at the time of publication, was how best to incorporate observed future prices into a standard price index. Alchian and Klein (1973) solve this problem by constructing a hypothetical asset price that would be observationally equivalent to having the full set of future

McGrattan and Prescott (2003) have developed a way to determine whether the stock market is overvalued or undervalued and applied it to the 1929 U.S. stock market. They found that the reason for the 1929 crash was not that the stock market was overvalued relative to fundamentals. Significant overvaluation of the stock market is a reason for concern, because if the market is overvalued, the likelihood of a crash is high, and a crash would result in large declines in net worth of people and corporations164. McGrattan and Prescott (2003) also raise the question if there are any consequences to the stock market being undervalued and give an affirmative answer. In particular, an undervaluation will lead to greater underinvestment in the corporate sector and lower economic efficiency.

In the question whether the U.S. Federal Reserve should consider the consequences of its policy for the value of the stock market, their answer is negative. They stress that “the role of the Federal Reserve is to maintain an efficient payment and credit system, and it should not consider the effects of its policies on the value of the stock market, while the central bank should not try to prop up the value of the stock market as it did in Hong Kong and Taiwan or depress the stock market as the Federal Reserve did in the United States in 1929” (McGrattan and Prescott (2003), p. 274).

prices. Bryan, Cecchetti and O’Sullivan (2003) propose an interesting method to try to approximate the Alchian and Klein (1973) hypothetical asset price by using a dynamic factor model. According to Filardo (2003) the authors have made a useful extension of the empirical methods to examine Alchian and Klein’s cost of life inflation measure but do not show how to resolve the bias induced by asset price bubbles. Additionally, he proposes that they construct a more unbiased estimator of the Alchian and Klein inflation estimate by trying to extract future price information with modern finance methods or by empirically controlling for asset price bubbles – which he admittedly views as neither particularly straightforward nor easy (Filardo (2003), p. 292-293).

164

A stock market would cause state and local pension plans to suffer large declines in the value of their assets, and this would necessitate increases in taxes if promises were to be honoured. The same decline would occur for private defined benefit plans, which would further reduce the value of the stock market. People with individual retirement accounts would also suffer losses. In such situations, there is a danger that policies will be adopted that have adverse real economic effects (McGrattan and Prescott (2003), p. 274).

Arguing on who should deal with stock market overvaluation or undervaluation other than the central bank, they accept that economists should convey to the public information about the degree of overvaluation or undervaluation. If the public has this information and acts on it, the problem of incorrect stock market valuation will not arise165.

According to Filardo (2003), if McGrattan and Prescott’s study is correct in its result that there was no asset price bubble at the height of the market, then the 1929 crash and its aftermath is a good example of the costs of fighting an asset price bubble when a bubble is not really present, and such estimates can be used to calibrate models in which this type of cost is a parameter. Overall, Filardo (2003) suggests that policymakers should be sceptical about reacting to asset price movements that look like bubbles (Filardo (2003), p. 294).