What should happen to prices when productivity jumps? Logically, they should fall.
So, shouldn’t prices generally have fallen during the great computerisation-driven productivity boom led by the United States in the 1990s? And, given the rapid increase in productivity of the enormous Chinese workforce, shouldn’t prices generally still be falling?
If so, why have they gone on relentlessly up? Why over the past 10 years of supposedly tough Reserve Bank action has inflation more often than not run in the top half of its allowable band — a band that now has a floor of 1 per cent inflation? Why has Alan Bollard gone through the top of the band?
Have central banks — and in particular, the United States’ central bank, the Federal Reserve Board (Fed) — been holding up prices that could have been falling?
Alan Greenspan steps down at the end of this month [January] after 18 years as Fed chairman. Some revere Greenspan as a guru. Others say he leaves behind a property bubble, a seriously unbalanced American economy and, to a large extent because of that imbalance, a seriously unbalanced world economy.
Poor Bollard is a pingpong ball on this oceanic turbulence.
Greenspan is famous for having warned of “irrational exuberance” when the Dow Jones index went through 6000 in 1996. A huge stockmarket bubble developed, which burst in 2000 at nearly twice the 1996 level.
But Greenspan believed central bankers should not prick asset bubbles in case they turn out not to be bubbles. They should mop up afterwards.
One reason a share bubble might not be one is if there is strong productivity growth, boosting profitability. Before most, Greenspan picked the huge productivity lift in the United States economy in the 1990s.
One who makes this point in Greenspan’s favour is Alan Blinder, a distinguished Princeton economist and former vice-chairman of the Fed under Greenspan.
Blinder is a Greenspan fan, calling him “an amazingly successful chairman of the Federal Reserve system,” and marvelling at his “stellar record” in a paper at the annual Jackson Hole conference of world central bankers in August. Greenspan was “both lucky and good”.
He commended Greenspan for “refusing to take away the punch bowl even though the party was going pretty good” and gave him “enormous credit” for keeping interest rates low even when unemployment got down to 3.8%. Inflation, after all, was still low.
And Blinder said, Greenspan mopped up after the stockmarket bust with skill.
But some ask if, even taking into account the productivity surge, there was not a point at which the stockmarket had got so far out of line with fundamentals that leaving interest rates low would overheat the irrational exuberance? If so, Greenspan seems to have been oblivious: just two months before the crash, he extolled “a once-in-century acceleration of innovation, which propelled forward productivity, output, corporate profits and stock prices at a pace not seen in generations”.
And might not even that low inflation he relied on for inaction actually have been higher than it looked on the surface — that is, the productivity surge could have brought prices down? If so, letting the bubble build does not look so wise.
In the January/February issue of Foreign Policy magazine Stephen Roach, chief economist at merchant bank Morgan Stanley, rates Greenspan anything but a guru.
Roach reckons the “accommodative” stance since 2000 has created bubbles in other asset markets, especially corporate bonds, mortgage-backed securities and emerging-market debt — and “the biggest bubble of all, residential property”.
Roach’s picture is eerily similar to the one we know here: families have accumulated debt at a rate 60 per cent higher than the economy’s growth rate; households are spending “near record high portions of their monthly incomes on interest expenses, leaving consumers in a precarious position, should either interest rates increase or the growth in incomes slow”.
Also eerily similar is the blowout in the current account deficit, to a “record 5.7 per cent of GDP”. To fund it, Roach writes, the “United States is sucking up more than 80 per cent of the world’s savings”.
Since Asian economies are “more prone to save and rely on export-led growth strategies”, they have acquired huge quantities of United States dollars which they recycle into United States Treasury bills.
“This effectively subsidises United States interest rates, thus propping up United States asset markets and enticing American consumers into even more debt. Awash in newfound purchasing power, Americans buy everything from Chinese-made DVD players to Japanese cars.”
It’s a sort of party pill for American consumers.
Some of that huge wash of Asian savings has fetched up here, pumping debt and fuelling an import surge and the house price bubble — and making Bollard’s job hell.
While the party lasts in this bubble world, Greenspan is a hero. When the bubble subsides — or implodes — he won’t look so good, from wherever in the world he is viewed.
But by then it won’t be his show. Ben Bernanke, also of Princeton, whose “Principles of Economics” textbook is on sale in the bookshop next to Parliament, will be Fed chairman.
While Bernanke “mops up” after Greenspan’s bubbles, he might reflect on whether central bankers should bother about asset prices, as Bollard does here.
Bernanke might reflect, too, on whether prices should still go up when productivity surges — and what a central banker might do about that.