Monday, December 8, 2014

"Asset inflation" aka a transmission channel

Asset values have been rising somehow intensively, following amid liquidity injection (QE) by major Central Banks over the last few years. A controversial, yet rather effective, policy choice. And this controversy, currently, derives from the asset bubble argument. In other words, the increase in the value of assets is a bubble, and, inevitably, it will burst. Is this policy controversy well justified? Perhaps, not very well.

I will not argue whether asset inflation is a bubble or not. That is not the point I am trying to make. I will argue, however, that the rising asset values is exactly how the whole policy should work! It is a key mechanism of transmitting monetary policy to the real economy. Not only for banks, but for households, as well. If you own assets, their value rises your net value rises, too, and, hence, you can borrow more or/and at a lower cost. Most importantly, households and businesses can remain solvent while deleveraging stops, and their liabilities rise.

However, there are a few shortcomings. Firstly, increasing asset value may indicate a broken transmission mechanism; cheap liquidity is used for stock purchases instead of financing consumption and investment through lending. Again, that is also good; asset value rises, increasing net worth etc. Even if the transmission channel was malfunctioning, the above stagnation price and GDP growth, in the US, suggest that this channel has recovered and is working.

Secondly, what happens if the value these assets starts deflating. Most likely, a correction will take place but I believe that central banks will intervene, once more, to contain it! And they must do so, or else we will get back to 2008. If central bankers react in time, not too late, they will be able to limit the asset deflation, and its consequences.Should they? Definitely, yes! One has to end what he begins. Central banks started some unconventional policy, and, subsequently, they will have to end it unconventionally. Nevertheless, stocks in the US keep rising despite the end of QE...

All in all, this controversy over QE and the day after it, has some valid grounds, but waiting for the Armageddon has not. For the US, price inflation is good, growth is good, end of QE cannot go bad, so don't worry too much, please. This is how it is supposed to work, this is how it worked.