I found it vague, at best; It wasn’t clear to me exactly what they were saying about the relationship between income inequality, loose monetary policy, and bubbles.

http://ideas.repec.org/p/fce/doctra/0917.html

I did a “quick read” of the voluminous -Report By The
Commision On The Measurement of Economic Performance and Social Progress- but I did not see any definitive statement on this issue.

http://www.ofce.sciences-po.fr/pdf/documents/rapport.pdf

inequality —> (greater) need for the fed to ease credit —> bubble.

Any thoughts? Supporting article?

http://curiouscapitalist.blogs.time.com/2009/04/15/the-asset-bubble-theory-of-income-http://utip.gov.utexas.edu/papers/utip_27.pdfinequality

Ok, now that’s done. You are looking at an artifact of how the economy now runs – inflation control is king, and unemployment is no longer a consideration. We will have a jobless “recovery” because we have both a regulatory scheme, a financial policy, and an economic intelligensia who prize profit over sustainability, efficiency over employment, and private ownership (and thus reward) over all else.

And we did it to ourselves thorugh who we elected to national office for the last 30 years.

The statguy says:
“In order for the Fed to actually be able to fully use monetary policy to keep the economy humming at full throttle, we need financial regulation (to avoid new liquidity being channeled into bubbles instead of real investment), better capital asset ratios (to help moderate moral hazard and asymmetric risk), and limited expectations of future dollar devaluation (which currently result from our huge debts, and China’s continued mercantilist policies that keep the dollar propped up).

The problem in this episode is that if asset prices are ahead of the real economy — in other words we are creating the next bubble — it is being cretaed by the household sector and not banks. So capital requirements will not do much to control that.

That is, if savings are rising and policy is very accomodative, you will cretae new bubbles. And if the Fed does not do anything, it is deeply worried that it will be blamed for again.

In the US the compression of low incomes was compensated by the reduction of
household savings and by mounting indebtedness that allowed spending patterns to
be kept virtually unchanged. At the same time, the limited safety nets forced the
government to pursue active macroeconomic policies to fight unemployment,
increasing government debt as well. Thus, growth was maintained at the price of
increasing public and private indebtedness.

Most European countries tread a different path. The redistribution to higher
incomes resulted in an increase in national savings and depressed growth. In the
past fifteen years the institutional setting, notably the deficit constraints embedded
in the Maastricht criteria and in the Stability and Growth Pact, resulted in low
reactivity of fiscal policies and restrictive monetary policy. Together with a
financial sector less prone to innovation, this limited consumer borrowing. The shift
in distribution resulted in soft growth.

Fitoussi/Stiglitz, OFCE 07/2009

All of the “hawkish” comments are an attempt by the Fed to manage expectations and convince the public that they are “really” serious” about controlling inflation. They need to keep inflation expectations down. If the market believes that the Fed will keep interest rates too low for too long, bond yields will rise and undermine the recovery. On main street we call this a long “con”.

Its a con because the Fed is trying to trick the market into believing something that the weight of evidence suggests will not occur. History teaches us that when government/Fed debt becomes as large as it is projected to be, when push comes to shove ,the easiest path to reducing the burden of debt is to create inflation by printing money. The view that inflation is the most likely exit strategy, is supported by the markets belief that the dollar will need to be devalued, and the way to do that is to create inflation. Its called a long con because we won’t know for a number of years how all of this will play out. In the meantime, the Fed hopes to keep the market on a short expectations leash.

Fed Policy,Bubbles, and Leverage:

Much of the current discussion centers around how to control excesses that develop during the business cycle, and how to mitigate the damage to the economy and taxpayers, when bubbles burst. Leverage is often cited ass a major component of the problem.
While leverage is undeniably an key issue, it is important to keep in mind that leverage does not work unless the return on investment exceeds the cost of financing that investment. You lose money and there is no incentive to invest when the return is less than the cost of financing.
So the key elements here are the return on investment and the cost of financing. The return on investment consists of two components – income and price appreciation. The income part, like profits or rent, is based on fundamentals; the price appreciation component is more speculative in nature. Pure speculation kicks in when the income part becomes minor and the asset is purchased primarily for its expected price appreciation; the asset is bought and sold like “pork bellies” -a commodity.
Speculation is propelled forward by leveraged players who magnify their returns by arbitraging the spread between the price appreciation return and the cost of financing the investment.
The big investment banks- GS, Bear Stearns,Lehman, and others played a key role in the current financial crisis. At the height of the crisis they were highly levered and perhaps half of their financing was short-term debt. The cost of that short-term debt was ,at the margin, set by the Federal Reserve. The Fed controls short-term interest rates through the Federal Funds rate. Loose monetary policy kept the real Fed funds rate unusually low during the period 2001-2005.
The low interest rate environment initiated the speculative buying in housing. The housing bubble gained traction as the speculative price increases continued to outpace the marginal cost of funds set by the Fed.
But for the loose monetary policy, leverage would not have been as effective, and the current financial crisis more benign.

Perhaps this is a lighter regulatory touch that could serve a similar aim.

“In the U.S., small businesses employ 50% of the country’s workforce and contribute 38% of GDP. Without access to credit, small businesses can’t grow, can’t hire, and too often end up going out of business. What’s more, small businesses are often the primary source of this country’s innovation. Apple, Dell, McDonald’s, Starbucks were all started as small businesses.” Meredith Whitney

http://online.wsj.com/article/SB10001424052748704471504574445470989162030.html

The investment banker Chris Whalen, testifying before a congressional sub committee, says he is not a big fan of regulation.

Whalen does not share Taleb’s view new financial products should be reviewed like new drugs by the FDA. Whalen says the government does not have the competence to analyze complex securities. He says the Fed is populated by monetary economists who could not even work on Wall Street.

Rather, he says, take a minimalist approach.

(1) Let the markets discipline the behaviour. Increase liability to the issuers by forcing disclosure and SEC registration. The trial lawyers for the large buy-side investors will make sure the financial instruments are credible. Otherwise the trial lawyers will “come over the hill like barbarians and they will feast”.

(2) Make dealer own some of the risk. They cannot just abandon their client after making a complex deal.

His minimalist approach makes sense. What do you think?
____

Hat tip to SJ and JK for link to congressional hearing. — Fascinating talking heads. — Greg Berman, James Rickards, Chris Whalen and David Colander in final 30 minutes.

http://science.house.gov/publications/hearings_markups_details.aspx?NewsID=2586

http://science.house.gov/publications/hearings_markups_details.aspx?NewsID=2586

http://science.edgeboss.net/wmedia/science/scitech09/091009.wvx