Pegging the S&P

Economist Roger Farmer, writing in the Financial Times, proposes that the government stabilize the S&P 500 to prevent a repeat of the Great Depression:

It is time for a greatly increased role for monetary policy through direct intervention of central banks in world stock markets to prevent bubbles and crashes. Central banks control interest rates by buying and selling securities on the open market.

A logical extension of this idea is to pick an indexed basket of securities: one candidate in the US might be the S&P 500, and to control its price by buying and selling blocks of shares on the open market.

Even the credible announcement that a policy of this kind was being considered should be enough to boost the markets and restore consumer and investor confidence in the real economy.

Critics will argue that this policy is dangerous socialist meddling. But I am not arguing that the government should pick winners and losers: only that it should stabilise a broad basket of stocks.

Tyler Cowen is skeptical; so is Mark Thoma:

What growth rate in the stock price index should we target? Should it be 8%? Lower? Higher? What is the correct time frame? Day to day fluctuations are quite volatile, we wouldn’t want to react to every movement in the index, so how do we come up with a core measure that gives us an indication of the long-run trend in stock prices? Does value weighting, as in the S&P 500, give the optimal index, or would some other weighting scheme do better? Do we only include financial assets, or should other asset prices such an housing price index also be targeted?

As I interpret it the most immediate effects of his proposal would be to a) place a price support on the compensation plans of 500 CEO’s and b) give a competitive advantage to 500 big companies at the expense of their smaller competitors. Most of the job creation these days is being done by small companies, none of which is in the S&P 500. Why should we be subsidizing the slow-moving dinosaurs at the expense of the fast-moving little mammals?

Also, which S&P 500? The S&P changes over time. Is the plan to embed the current companies in amber?

2 comments… add one
  • PD Shaw Link

    I’m following (ambivalently) the argument for greater intervention in the economy until we get to the idea of doing so to support stock prices. Why stocks? Instead of boosting the value of Proctor and Gamble stock, why not buy a bunch of soap and giving it to a worthy cause?

    “Central banks control interest rates by buying and selling securities on the open market.” The Fed only buys bonds, right? I can see the case for the government making sure that business can get the credit it needs to expand or maintain operations during a temporary contraction. I feel like the word “securities” is being used with mischief aforethought.

  • I have been thinking about this in some depth… it seems to me that central bank policy is not achieving one of its goals, which is boosting private investment. Normally a reduction in interest rates will make this happen, but for various reasons it is not doing so now.

    I happen to think investment in equities might be a way to address this, but not in the way Roger Farmer suggests. My version is here.

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