Slaves of the markets

CENTRAL banks are supposed to target inflation and in some cases, economic growth or full employment. As the “lender of last resort”, they also have responsibility for safeguarding the financial system. But do they in fact target asset prices as well?

That has been the suspicion from the late 1980s onwards, when the Federal Reserve began cutting interest rates when equity markets wobbled. This approach became known as the “Greenspan put” (Alan Greenspan was the chairman of the Fed from 1987 to 2006, and the put option is a form of insurance against falling prices). The implicit guarantee from central banks became a bit more explicit in the era of quantitative easing (QE)—the creation of new money to buy assets. Central banks hoped that QE would have a “portfolio rebalancing effect”, with investors being forced out of low-yielding government bonds and into corporate debt and equities.

However, the relationship between market movements and central banks may have an even longer history. That is the implication of new research by Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School for the...Continue reading

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