As ever, the US Fed stimulates optimism but not much growth

SERIOUS MONEY:US STOCK PRICES have been unusually buoyant through the lazy days of summer, and have jumped almost 10 per cent since the end of May, to within just two per cent of the levels that prevailed immediately before the financial crisis entered its most dangerous phase during the summer of 2008.

The most recent turnaround in the stock market’s fortunes has been somewhat surprising, given that virtually all of the latest economic data points to nothing better than sub-trend growth, while “Corporate America” has just completed its most disappointing quarterly-earnings season – at least, versus bottom-up expectations – since the current upturn in equity values began more than 40 months ago.

The major market averages’ resilience against what would appear, on the surface, to be bad news, almost certainly reflects investors’ blind faith in the Federal Reserve’s ability – and willingness – to deliver infinite rounds of emergency stimulus in the face of sagging growth, that should, in the bulls’ eyes, not only prevent the realisation of unfavourable outcomes, but perhaps even return the economy to a more robust growth trajectory.

The close to God-like status afforded to the inhabitants of the Marriner S Eccles Federal Reserve Board Building in Washington DC is warranted, the bulls argue, by the fact that the monetary authority delivered the “Great Moderation” through the mid-1980s and beyond, and managed to prevent a repeat of the “Great Contraction” of the 1930s, in the face of the largest systemic crisis in generations.

It is clear that the “Greenspan Put” has simply evolved into the “Bernanke Put” – but, investors’ increasing dependence upon central bankers’ continued wizardry could well be nothing more than wishful thinking.

It is beyond dispute that the “Great Moderation” was a very real phenomenon, whereby a broad-based decline in macroeconomic volatility began during Paul Volcker’s second term as Chairman of the Federal Reserve, and persisted throughout the Greenspan era. Indeed, the volatility of quarterly real GDP growth more than halved in the period from the final quarter of 1983 to the end of 2007, as compared with the previous quarter-century. Further, the dramatic decline in macroeconomic uncertainty was not confined to quarterly output, and extended to a multitude of variables including inflation, employment, and exchange rates.

The “Great Moderation” was well-known to investors for several years, but captured the public imagination in the spring of 2004, when Ben Bernanke delivered a speech given to the Eastern Economic Association, which concluded that, “improvements in monetary policy . . . have probably been an important source of the Great Moderation”. Various central bankers have put forward the same view, which has been dubbed “enlightened discretion”, but numerous academic studies have poured scorn on this hypothesis.