OECD Chief Economist: It's Time To "Temper The Frothiness" In Markets

Excerpted from MarketWatch's Greg Robb's interview with Catherine Mann, a former Fed staffer and current chief economist at The Organisation for Economic Co-operation and Development, who is concerned the Fed is "crying wolf," always threatening a rate hike but not moving. Simply put, The Fed’s inaction is fueling unproductive moves in asset markets, Mann said.

...we argued that September would have been a good idea because it would have put behind us and behind the emerging markets and behind the markets, the timing of the first move.




Now going forward, we continue to have uncertainty about global trade, about the magnitude of global trade — it is quite low compared to global GDP— but this is something that the U.S. economy has been dealing with for a while. That is not new. Commodity prices? Again this is not new. We’ve been dealing with this for a while.




What is a new dimension between September and October is, that unfortunately, there is a lot of speculative capital that had been repositioning itself all summer for the expectation of a September hike. Now, since that didn’t happen, all that capital starts running back to where it was before, creating some problems in emerging markets with basically the most speculative money going for six weeks more of higher yields. So that is the unfortunate new aspect, I think, of where the global economy is. And that, again, would suggest that the best thing to do is to take the first move off the table by doing it, and then being very clear about the shallow slope of the trajectory of interest rates going forward.

How can the Fed raise rates when inflation is not on horizon?

I go back to a paper that Ben Bernanke gave at the Jackson Hole conference in 2012 where he set out in really very clear terms about the pros and cons of quantitative easing, which of course we were still in the process of doing at the time.

  • The pros were you want to lower interest rates, reduce the slope of the yield curve, get the credit channel moving, use the wealth effect to bolster consumption and business investment.
  • The cons were, what would we need to know when it was time to kind of take the foot off the accelerator, and it had to do with disruptions in the Treasury market and it had to do with a change in the nature of asset markets.

So when I look at the Treasury market functioning, I see some problems there, with liquidity, some spiking. So, some disruptions or malbehavior in the Treasury market, I see as one indicator, that even though the objectives of inflation and unemployment have not been reached.

The second indicator that was outlined in the Bernanke speech was concerns about what was going on in asset markets - housing markets but also in equity markets.

But if you look at the equity markets and you look at what is supporting equity prices — how much of that support is coming from real economic activity versus from using stock buybacks, using cash on balance sheet for stock buybacks, or mergers and acquisitions, to reduced competition in the marketplace.


These are the sort of stories that if there were a small increase in interest rates, you would temper some of that frothiness. Is this really a thing you want to be going on in asset markets? Is this really representative of the kind of asset-market activity that is supportive of the foundations for more robust growth in the U.S. economy? The answer has to be no. And so a small change in interest rates would temper some of that activity in the asset markets. So I go back to the Bernanke speech — it was a cost-benefit speech, and I look at those two elements and I say: well, the cost-benefit equation has shifted.




You’ve got the market participants with the shortest horizon having the greatest incentive to do what they want to do for six weeks at a time. That is not productive activity, whether it be in emerging markets or in the U.S. marketplace, these are not productive investments.


Eliminating the incentive to engage in that kind of activity seems to me to be a good idea. We know that 25 basis points is not going to do that much, on the margin, to affect business decisions on whether to undertake real investment or not.




there is a possibility that you will see some equity market correction, but since I see a fair underpinning of where we are in equity right now is based on some of these not-really conducive to real economic activity anyway — stock buybacks, the mergers and acquisitions – taking a little bit of the top off of that is not something that is going to negatively affect the economy.


There would be a proportion of the population that would have less capital gains — but they’ve been enjoying very big capital gains, and it is a narrow segment of the population. And for firms, for those who are in the equity markets, the bulk of them have a lot of ammunition to work with on their own balance sheets, so 25 basis points is not going to make a difference to them.

I think it is hard to argue that [the economy] is overheating, but my argument for having the first interest rate rise has very little to do with the inflation target. It has a lot to do with unproductive use of resources in asset markets and so that’s my story, not the one that is the argument for the inflation target.

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