I wanted to follow up on my post from last week in which I asked: “Will Quantitative Easing II (QE2) Result In the Next Bubble(s)?” And to compare that post to another post from October of 2009: “The Next Bubble?”
In my post from 2009, I wondered whether the Federal Reserve’s efforts to keep short-term interest rates down would result in a stock market bubble. Certainly, the stock market has risen since October of 2009. Whether that increase is a bubble or a reflection of real value is hard to say. Is there a reason for the increase in the stock market in the performance of the economy? Or did the stock market go up because the extra money the Fed pumped into the economy needed some place to go and, since consumer prices and housing could not go up because of external factors, the only place it could go was the stock market? We don’t know yet, and we won’t for a while longer.
In any case, the Fed is doing it again. The idea of QE2 is, inter alia, to push down medium and long-term interest rates (short term rates already being almost zero), which will encourage people to go into the stock market to get a decent return, because interest rates on CDs and bonds are so low.**
In last year’s post I was just worried about a bubble in the stock market. But that concern was too narrow. I did not realize then about the possibility of other bubbles. As I mentioned in last week’s post, we could be seeing a commodities bubble right now. And there are real concerns about bubbles in other countries, especially those offering a better rate of return than the US. Will some of our excess money flood into one or more of those economies, starting asset inflations that could turn into a burst bubble if too many people try to leave at the same time and find that they can’t because of a lack of liquidity?
Last week’s post concluded: “I wonder if it might be better to grow a little slower now to avoid the risks of yet more bursting bubbles in the future.” I don’t think this was worded right. As written, it could have been interpreted to say that, what the Fed is doing, with QE2 and all, would definitely cause us to grow more quickly than alternative policies and that the only problem was the possibility of bubble(s). That is not what I meant. I do not think it is at all clear that the Fed’s current policy is going to give us more growth than some of the possible alternatives. Rather, the problem with the current policy is twofold. First, will it work better than the alternative(s)? Second, will it result in yet more bubbles?
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* An alternative title for this post, which I decided not to use, was this: “Is the Federal Reserve Creating More Bubbles Than Lawrence Welk?” I think you can see why I decided not to use it.
** And, as I said before, the idea is that this will cause the stock market to go up, which will make people feel wealthier, which will cause them to spend more, which will boost the economy, which will cause the stock market to go up, etc.
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