Nice to see some ideas I proposed a good while ago getting a bit more of an airing, namely governments running open market operations in assets other than their own bonds (pdf) in the process of managing the economy. I suggested that governments should purchase equities on a countercyclical basis because it both
- made them money
- improved macro-economic outcomes
Now the second of these rationales is gaining some support as people think about the role of government as a market maker of last resort. Note several things about the subsequent discussion on Thoma’s thread. Firstly the case has been made in terms of ‘targeting’ asset prices, in the way open market operations of the central bank target short term interest rates. This is a determinate process. I don’t think you can know enough to target share prices. In fact I think it’s batty when put like that.
But that’s very different to saying that governments can extend their ‘market maker of last resort’ role to leaning against the wind of excessive optimism and pessimism in these markets. That’s pretty much what we do in the foreign exchange market (when we’re not pursuing the occult practice of ‘smoothing and testing’). It makes perfect sense – the government expects to make good money and make the economy less volatile in the process. Everyone’s a winner except the momentum traders who followed and contributed to the momentum a little too much.
After five thousand questions Mark Thoma concludes.
Thus, while I certainly think this is a fruitful area to investigate, particularly in light of recent experience with the housing and stock price bubbles, we have more thinking to do and more regressions to run before we are ready to implement this kind of policy.
This is very typical of policy debate in general. Someone comes along with a proposal to improve something. To him it seems pretty obvious that things can be (perhaps greatly) improved if we do something a little different. Then people come out of the woodwork and say ‘what exactly do you mean?’ Now inevitably the person suggesting something new won’t know exactly what he means. He is, after all, observing how things are and suggesting something he regards as a compelling improvement. But rather than say ‘yes, the argument for it is compelling, though it has many implications that we should also be thinking about’ the interlocutor will call for everything to be sorted. Trouble is, that it is in the nature of things – and of human thought – that comprehensive rethinking can rarely if ever be done. The threshold for action should not be that we’ve got all the details worked out – that’s usually the sign of self delusion more than anything much else. The threshold is that we have sufficient understanding to believe that the action we are taking can bring substantial benefits, and we don’t believe it will produce to highly undesirable perversities or sideeffects.
I also think this problem is particularly pronounced in economics where the practitioners think in models and so are highly anxious about aspects of policy about which there is uncertainty. To repeat, there are always plenty of aspects about the future of policies – for governments or for other organisations – that are uncertain and this often applies nearly as much to existing policies as it does to new ones. One needs to manage them as intelligently as one can.
These words of mine are heartfelt because lots of the things I suggest are subjected to the same kind of death of a thousand details. Thus when I suggest that fiscal policy is not working that well and could be assisted if it were recast more in the mould of monetary policy, lots of people seem to agree with this proposition, but then want to know a thousand other details – all of which are contentious. So the best – and a thousand different versions of it – become the enemy of the good.
Now it’s fine to be thinking about all Thoma’s questions. But we haven’t got a lot of the analogous questions solved for open market operations in the bond market. We muddle along fairly confident (most of the time) that doing what we’re doing is better than the alternative of inaction. When we change interest rates we don’t work out all the implications. We can’t. We just do the best we can. And the same goes for open market operations in equities. There are obvious gains to be had in extreme situations, and so the policy can be pursued in those circumstances. And we can keep thinking about how far we want to go beyond that and develop our institutions accordingly.
Note however that the proposer of this policy does not argue for the policy in extremis. The way he argues for it, is not as some pragmatic enhancement to what we do, but a fully fledged policy to target equity prices (not individual ones but the price of a basket of equities). And so the whole discussion goes from the outset to the kinds of academic considerations that I’m arguing are not central to the question of whether it’s a good idea to take some action right now.
Note for those responding to this that much of the reaction to the policy as if it is in the same family of policies as using monetary policy or short term interest rates to control asset prices. It’s not. It’s using open market operations (the purchase and sale of securities) to influence their price – not to mention as vehicles for profitable investment for the state. So where the central objection to using interest rates to target asset prices is that it’s sending one instrument out to control two variables, here we have two instruments and two variables.