Q: You’ve said the booming stock market of the last few years was a symptom of America’s weak economy, not a sign that the economy was recovering. What did you mean by that?
A: The stock market had done well for basically two to three key reasons—low wages, so when wages are low profits are high; low interest rates, but the low rates are because the economy is sick; and the third was through much of this period the dollar was weak, and when the dollar is weak and our multinationals make profits abroad, when that money gets converted back into dollars it looks very strong. Now that the dollar is strong, it’s having just the opposite effect.
A lot of the skittishness now is people realizing the fundamentals weren’t that strong; interest rates may be going up faster than the fundamentals might justify because of the deserved concern that quantitative easing and low interest rates lead to asset price bubbles including the stock market. And that’s the agony the Fed [the U.S. Federal Reserve] is going through. The economy is not in a robust state, with no signs of inflation, so for all of the talk about the increase in the interest rate, it might not happen.
Q: How does America get out of this mess—keeping rates low to support the real economy may spark asset bubbles and speculation in stocks, which then brings the need to increase rates even if the real economy hasn’t improved?
A: My view goes back to what we should have done, which was we needed more fiscal stimulus. We shouldn’t have relied as much as we did on monetary policy. But given the politics in America, that wasn’t going to happen, and the Fed took what you might call the second-best approach. It still had a responsibility to stimulate the economy, and was trying to balance those various risks.
Because we put all the burden on monetary policy, it doesn’t have much room to maneuver now. It can decide not to tighten, but it can’t loosen. So its ability to respond is very asymmetric. The most that it can do is to postpone the actions it was going to take.
So as an economist I can answer your question very easily—there’s what we should do—but politics in the United States doesn’t make it very likely.