Four years before the stock market bubble burst in the summer of 2000, Fed Chairman Alan Greenspan warned investors of "irrational exuberance." Now, in the latest issue of The Milken Institute Review, two economists specializing in monetary policy ask whether the Federal Reserve should have intervened before the market collapsed.
In a review of stock market bubbles over the past century, and the subsequent impact of intervention by the Fed, Frederic Mishkin of the Columbia University Graduate School of Business and Eugene White of Rutgers University argue that much depends on the environment in which the bubble is pricked.
"The problem facing monetary policymakers is not stock market bubbles, but financial instability — which may or may not accompany market crashes," the authors write. "By focusing on financial stability rather than stock prices, central banks are both more likely to manage their core task well and to maintain political support for their independence."
Specifically, if the start of a decline increases the "risk premium" on private credit — the difference in interest rates between government debt and that of creditworthy private borrowers — the bubble is likely to damage the "real" economy, they say, and intervention is appropriate. But that didn′t happen in the summer of 2000 because "weak banks had been culled through failure and merger, while new regulations and a long period of growth have made banks less susceptible to a sudden decline in asset values. Thus, there was no reason for a squeeze on less creditworthy customers, despite the decline in the stock market."
Also in this issue of the Review, Nicholas Eberstadt of the American Enterprise Institute speculates about the likely impact of AIDS on China′s economic future. Drawing an eerie parallel to the current SARS outbreak in that country, Eberstadt writes:
"A close look suggests that the country′s economy is far more vulnerable to such a tragedy than one might expect from a country with a sterling record of growth. ... China′s impressive record to date in improving public health does not guarantee that an emerging epidemic will be handled with equal efficacy."
Other highlights from the new Review:
- Pension consultants Steven Nyce and Sylvester Schieber describe some of the consequences of aging societies — most notably Japan and Europe, but also the United States. "In the long term, developed economies will not be able to improve living standards if productivity gains do not outstrip declines in the number of workers," they write. "There simply will not be enough workers to bear the burden of an ever-growing elderly population."
- Greg Rushford, publisher of The Rushford Report, takes a swipe at the U.S. International Trade Commission, a federal agency charged with administering key parts of America′s trade laws. "The extraordinary lengths to which the ITC has gone in some cases to dodge its obligations might provide comic relief to those who appreciate the more outrageous workings of politically compliant bureaucracies," he writes. "Unfortunately, in the process of pleasing the Stand Up for Steel lobbying group, the ITC has created a serious rule-of-law problem. There should be little humor in that — at least not for anyone who cares about America′s credibility with its economic allies."
- David Evans of National Economic Research Associates and Milken Institute Review Editor Peter Passell tell you "Everything You Wanted to Know About Two-sided Markets" — those where sellers must convince two sorts of consumers to use the product in order to make it valuable to either (think dating clubs, or credit cards). "The complexity of operating in two-sided markets creates challenges for investors and managers, who face unfamiliar problems in identifying winning strategies," they write. "More important from the perspective of public policy, it challenges regulators to rethink the way they judge the health of competition."
This issue includes two book excerpts — one from The Myth of Market Share by Rich Miniter, who argues that obsession with market share often undermines corporate profitability, and Re-thinking the Networked Economy by Stan Liebowitz, who takes a withering look at the "lock-in" strategies that doomed most of the dot-coms.
Also in this issue is an interview with Yale University economist and stock market guru Robert Shiller; reflections on the pros and cons of globalism by Milken Institute Senior Fellow Michael Intriligator; a new and very different look at the returns to investments in education by Robert Haveman and Barbara Wolfe of the University of Wisconsin; a charticle by Institute Senior Fellow William Frey on the latest trends in America′s commuting habit; and an off-the-wall "Economist at Leisure."
The Milken Institute Review is distributed to some 10,000 corporate and financial executives, policymakers, academics and journalists throughout the world. Its editor is Peter Passell, former economics columnist for The New York Times.