Monetary Stimulus Is About More Than Just “Goosing” Stock Prices

There are two big contradictory myths out there about monetary stimulus and its impact on savings and investment. One is that it’s a form of “punishing savers” which would only be true if savers as a class were exclusively invested in fixed-coupon bonds. The other is that it’s simply a means of goosing stock prices.

The impact of monetary easing on share prices is real and important, but it’s not some kind of insidious subsidy to stock-owning fatcats. The reason is that there are two kinds of reasons share prices can go up. One is that investors revise upward their expectations about future economic growth. The other is that investors revise upward their expectations about the future profit share of GDP. Using the stock market as an all-purpose indicator of economic health is a big mistake because a larger profit share of GDP isn’t in any obvious sense good for the average person. But the key point about monetary easing is that there’s absolutely no reason it would have that impact. Insofar as the announcement of a new monetary initiative boosts share prices, that must be an indicator of an upward revision of growth forecasts.

Now it’s true that you sometimes hear talk about the “portfolio balance channel” as a way that QE boosts the economy. The idea is that people get better news about their 401(k) or IRAs and then spend more.

That matters but I think it’s of secondary importance. The key thing is that the existence of the portfolio balance channel is one of the reasons that the central bank credibility problem doesn’t arise in the real world. Rising expectations of future growth lead to higher share prices and all else being equal higher share prices should cause you to revise your expectations of future growth upwards. So portfolio balance effects reenforce expectations effects. But I don’t think they work in the presence of bad communications or expectations-setting. The direction of causality is that monetary easing amidst a depressed economy leads to a better growth outlook which leads to higher stock prices.