 |
Mises Institute, Mises wire, April 11, 2019,
4 pgs.
|
|
| |
Reviewer Comment:
A libertarian view of the current actions of the FED. No doubt true. The
questions are: "How long can this continue? and what will happen when it
ends?"
|
|
| |
Dr. Polleit questions the actual
effectiveness of central bank monetary policy in which the investors in the
financial markets show great confidence. He asks the question: "What is
the actual relation between the interest rate and asset prices, stock prices in
particular?" To answer he proposes to examine the "Gordon Growth
Model" which 'shows the functional relation between a firm's stock
priceand its profit level. the interest rate, and thefirm's profit growth
rate."
He provides the formula:
stock price=D/ (i - g) in which D=dividend: i=interest rate; g=profit growth.
For example, he gives a D=$10 - - i=5% and g=0% the stock price is $200 - this
results in ( 10/(.05 - 0)=200.
Then if g increases to @% the stock price should rise to $333.3.
If the central bank reduces the interest rate to 4% the stock price should
increase to $500.
If g then decreases to 1% the price would decline back to $333.3 and if g
declines further to .0005% the price would fall to $285.7
He provides a bar graph to depict this. He notes that according to the formula
the central bank can increase stock prices by lowering the interest rate. But
he asks "what about the effect the interest rate has on firm's profit
growth?"
|
|
|
Dr Polleit states that if the bank sets
interest rates very low that could take the energy out of the market. It could
allow unprofitable businesses to continue which would impact better businesses.
That would then have a serious effect on product markets, "resulting in
lower growth and employment." In turn that would cause the government to
increase deficit spending, thus diverting still more resources to unproductive
purposes.
|
|
| |
He describes a cascading situation in which
the central bank policy of very low interest rates generates increases in stock
prices for a while, but then investors recognize the problem and reverse their
belief in future business increase. Once their selling of stock begins it will
cascade into more and more selling. The decline in stock prices then would
impact other asset prices - for instance raw materials, housing, and industrial
goods. All this would trigger defaults in the credit markets making it
difficult for debtors to service their debts.
|
|
| |
He asks the question: if and when the
government via the central bank then attempted to support the credit markets by
creating more 'money' to whom would it give the new money? Who would know how
much 'new money' to create?
|
|
| |
His point in this essay is to prove that the
current monetary policy of very low interest rates is already producing harm to
the economy. It is a 'self defeating' policy. And the longer the current policy
continues the more dangerous it is.
|
|
| |
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
