Letter: Monetary policy has boosted the stock markets

Edward Chancellor makes a right and important point (“Tighter inflation targeting for central banks has caused economic damage”, Rae, 25 July). The pursuit of fixed targets for inflation has caused great damage to economies through excessive monetary easing. However, there is no evidence that monetary tightening to limit inflation has had any other than beneficial results, except when excessive easing has been necessary in the previous period.

The consensus model for the economy, as pointed out by Jorge Akerloff and Ricardo Caballero among others, assumes that there is only one balance that needs to be maintained to maintain economic stability – namely between supply and demand. However, it is increasingly recognized that this is just one of many ways in which the consensus principle is wrong. There is more than one inequalities that can derail the economy.

Monetary policy should not be used to support demand when it drives the stock market to absurd levels. We know he did this today with the q ratio, which is the ratio of the share market value to the corporate net worth. Since this ratio is the average return, stock prices should decline unless asset prices increase dramatically through inflation.

Share prices fall much faster than they rise and their decline is often accompanied by financial crises. Thus it is possible, though not certain, that we will have another within the next year or two.

We must try to avoid such high risks and recognize that they arise from the consensus economic principle on which policy is essentially based.

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Andrew Smithers
London W8, UK

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