NCPA - National Center for Policy Analysis

Will Greenspan Prick The "Speculative Bubble"?

March 22, 2000

The Federal Open Market Committee, the policy-making body of the Federal Reserve, is raising interest rates again to cool the stock market. The Fed believes that rising stock market wealth is fueling excessive consumption that could trigger inflation.

Federal Reserve Chairman Alan Greenspan has warned for years that the stock market is unsustainably high -- implying it is in a bubble that eventually will burst, with possibly dire consequences. And although Greenspan has said it is not the Fed's job to burst bubbles, its policy of tightening interest rates cannot be justified on any other grounds. Outside the oil sector, signs of inflation remain nonexistent.

Interestingly, a number of Federal Reserve bank studies have concluded it is a bad idea for the Fed to be targeting the stock market.

  • For example, in 1996 the Federal Reserve Bank of St. Louis concluded that equity prices do not predict changes in the general price level: "The pace of increase in stock prices is not itself inflationary, nor are stock prices particularly useful in helping to gauge inflation trends."
  • Last year, the San Francisco Fed concluded that the Fed's policy in the late 1920s, when it was also concerned about a stock market bubble and raised interest rates to deflate it, was mistaken and contributed to the Great Depression.
  • And a 1999 study by the Federal Reserve Bank of Atlanta found that economic theory regarding financial market bubbles is too weak to accurately identify them or guide monetary policy.

A growing number of economists question the Fed's apparent obsession with the stock market. They say it should just stick to maintaining price stability and let the market take care of itself. At some point, the economic risks from higher interest rates will exceed those of a stock market bubble.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 22, 2000.


Browse more articles on Economic Issues