I haven't read the 2003 essay yet, but from scanning it, it seems like it has the part whole fallacy and retrospection in it. Fed funds go down (and short term interest rates go down) in conjunction with stock market big declines and the reverse. Would have to waste my time looking at this self serving hedonistic paper with its Marilyn Monroe syndrome of wishing to show like Doc Greenspan that he is still an academic, even with their half of all financial economists on their payroll in the thousands , but may waste my time doing it some day and giving it a good review.

Gary Rogan comments: 

The main discovery in Monetary Policy and The Stock Market   is that what they actually regulate is risk aversion. Assuming the discovery is correct, the surprising thing is (well not really, but it should be) that it doesn't give him any pause that he is supposedly playing with the psychological disposition of millions of people like, well, a maestro manipulating an orchestra or an inanimate instrument. His brazen recent behavior can be explained by the same level of concern for manipulating human beings as is usually displayed in behaviorist literature towards rats given electric shocks in the lab.

Victor Niederhoffer decides to review the paper:

 It is amazing to me that in a 10 second scan of the Bernanke paper, I was able to come to correct conclusions except on the Marilyn Monroe factor. This appears to be my main ability aside from hard rackets squash now defunct. I am very good at spotting fallacies and folderol in scientific papers in an instant. I have now read the paper dated 2003 that the current Fed Chair wrote on the effects of monetary policy. I was wrong to characterize it as a Marilyn Monroe syndrome as he was not the Chair at that time, and his research would seem like a legitimate project for a Governor. I would characterize it more as a prince waiting in the wings type of project with its many conclusions very favorable to the then prevailing Chair's views on asset bubbles and exuberance and the role of monetary policy. Sort of like a member of the family proving himself in some difficult task.

However, I was correct in my assessment that the paper suffers from the part whole fallacy. The stock market and interest rates move in the same direction. When the stock market goes down, the interest rates go down. The cause cant be determined as their both co-terminus. However, given that the interest rates are down, one already knows that the stock market is down. Thus, it's a part whole, descriptive type of thing that has no predictive or scientific value.

The second part of the article where they use a regression equation to estimate the parameters of a forecasting model, and then use the forecasting model to determine effects, has so much statistical variability relative to the amount explained as to not be worth even considering. The estimates are changing and variable and doubtless have no statistical significance. But of course, when stocks go down, vol goes up and this could readily be measured by the vix. But again, it's the stock market move that causes the vix move, not the interest rate move. Using Granger type things as to which comes first, and being a market practitioner who sees the interest rate lag over and over again. At the minimum, the idea that the risk premium goes up because of interest rate moves rather than the direct effect of the stock market moves is completely undetermined and ambiguous.

It is good to know that the current chair is so conversant with stock market moves and the effect of changes in announced policy on same. In the good old days, whenever the stock market took a big swoon, as in the French inside trading day move, you could always count on a discount rate reduction or some such. But now, that the rate has been reduced to oblivion, indirect measures that affect expectations for the stock market must be used and it's good to know that the Chair is conversant with all these nexus, but hopefully he will ask his colleagues in the micro markets field to do a little more careful and scientific teasing of the data so that he will not suffer from so many statistical and market fallacies in the future. 

Rocky Humbert replies: 


I agree with you that this isn't a great paper, however, I think your statement "the stock market and interest rates move in the same direction" is rather different from the paper's conclusion. A better summation might be "interest rates and risk premia move in the same direction" (since the authors emphasize that surprise movements in fed funds have inconsequential effects on expected earnings/dividends.") It seems that you are focusing on VIX — whereas the authors are NOT focusing on VIX; they do cite Campbell & Cochrane 1999 et al in observing that during recessions the macroeconomic environment is more volatile. Yet if your point is that the VIX correlates with an increased volatility in macroeconomic indicators, I would be interested in seeing some evidence (tested to your satisfaction) which demonstrates this relationship. I am unaware of such research.

Victor Niederhoffer replies:

The paper is all mixed up with the thing you said and what I tested. All they had to do was look at the change in interest rates after the announcement and then look at the predictive properties of that change on stock market subsequently. They would have found nothing. And if their results through 2003 showed anything it would have been vitiated by the last 8 years.

Victor Niederhoffer reflects further:

But of course the main problem is that the Fed’s action signals things. And when they now signal that they want a lower interest rate, the market mistakenly believes that they know something extra about the economy and it’s going to be weak, and that's bearish for stocks which of course is bearish for interest rates.

Thus the ever changing cycles insures that the effect will be opposite from what the former Governor found.

One doesn't expect someone from the august greens at Nassau to read Bacon on ever changing cycles but someone should apprise him of its gist. It explains why the actions these days are so opposite to what the Fed and their past, present and future colleagues would believe.

But of course the main problem is incentives. Inventives. Yes, that’s much more important than a historical study of what didn't work during the depression. The incentives were ruined there the same way that they are ruined today. At that time, the business people threw up their hands in hopeless resignation that they were going to be strangled by the interventions and regulations and negation of the American way. And now, the incentives are ruined by seeing all the bad investments of the clients and ( okay I want say it ) the ” Banks” being bought by the Fed so that they can replace the loans that would have been assets on their balance sheets by yet more purchases of government bonds.

The public senses the same way they sensed when the sisters played each other that something was wrong. That there is no such thing as a free lunch. That the money that is being used to lend to banks and others around the world has to come from somewhere. That there is going to have to be an evening when the piper must be paid. So they circle the wagons. And the businesses that aren't receiving the direct aid, those that are not in the loop, desperately search for a safe haven by retrenching and canceling their plans to hire. Of course the problem was described by Gogol or was it Max Nordau in the image of the man rowing on the lake knowing that the dusk was near, I think.


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