Markets and Central Banks

Unfortunately, politicians and policymakers keep missing the significance of sporadic outbreaks of headlines like “World Stocks Rise on Hopes for Central Bank Intervention.”

My point here isn’t that policymakers should make high equity prices as such a goal of policy. But they ought to consider that historically speaking, there’s no particular reason to think of inflationary policies as being good for equity owners. But during this particular crisis, inflation expectations and the stock market have been highly correlated. The last time I wrote that, a lot of commenters seemed to think I was arguing that in general inflationary policies have this effect. The point is precisely the reverse. The emergence of a persistent correlation between the two is unusual and constitutes evidence for a world economy facing a persistent shortfall of demand.

You can also see this playing out in the microdata. For the past year, American manufacturing has been growing, but construction’s still been in its long funk and overall unemployment was very high. And yet this week we got data indicating that construction spending is back on the rise. Tragically, at the very same time we’re looking at a decline in factory orders. It’s not that we’re too supply-constrained to build buildings and run factories. We have enough manpower and capital goods to walk and chew gum at the same time. But we need demand.