Why QEII Wont Work Based On Studies Conducted By Robert Shiller

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Robert J. Shiller

Yesterday I wrote an article about why I think Bernanke is implementing QEII. One of my theories is that Bernanke is trying to inflate certain assets such as real estate and stocks.

I wrote the following about stocks:

With the Fed’s purchase of massive amounts of treasuries it will likely lower yields on bonds. Bond yields are already dangerously low and although I would not call it a bubble, I would not buy any medium or long term bonds at this moment. Bernanke knows if bond yields fall other asset classes including the stock market and the housing market could rise in value. A rise in housing prices would obviously solve many economic problems and help banks with bad loans prosper again.

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In terms of stocks; an increase in the stock market does help increase confidence. If people see their 401Ks rising in value they are more likely to purchase goods which will lead to an increase in consumer spending which (for better or worst) is very important to our economy. In addition, businesses will have a lower cost of capital because they can issue stock at higher prices (and debt at lower prices). Many companies have been taking advantage of low interest rates to issues debt, and I suspect if stock prices increase companies will start raising more capital through issuing additional shares.

However, here too Bernanke must be careful. An inflated stock market that is based on speculation and low interest rates can create a stock market bubble. Stock market returns in the long run are based on earnings and not low interest rates. Bernanke might be creating a stock market bubble which could just as easily crash as it rose. In addition, the market might get scared of all the possible negatives that come along with QEII and it could lead to a market decline. Bottom line is that Bernanke is taking a huge gamble if he is trying to inflate the stock market.

I found an excellent document on Pragcap.com by Robert Shiller. Shiller is one of the only real economists today in my opinion, and successfully predicted by the tech and housing bubble.

Here first is a brief bio about Robert Shiller from Yale’s Website:. I use the term brief very loosely since Shiller has such an impressive resume.

Robert J. Shiller is the Arthur M. Okun Professor of Economics, Department of Economics and Cowles Foundation for Research in Economics, Yale University, and Professor of Finance and Fellow at the International Center for Finance, Yale School of Management. He received his B.A. from the University of Michigan in 1967 and his Ph.D. in economics from the Massachusetts Institute of Technology in 1972.

His book Irrational Exuberance, is an analysis and explication of speculative bubbles, with special reference to the stock market and real estate. His book The New Financial Order: Risk in the 21st Century is an analysis of an expanding role of finance, insurance, and public finance in our future. His book The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It, published in September 2008 by Princeton University Press, offers an analysis of the housing and economic crisis and a plan of action against it.He co-authored, with George A. Akerlof, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism published in March 2009 by Princeton University Press.

His repeat-sales home price indices, developed originally with Karl E. Case, are now published as the Standard & Poor’s/Case Shiller Home Price Indices. The Chicago Mercantile Exchange now maintains futures markets based on these indices.

He has been research associate, National Bureau of Economic Research since 1980, and has been co-organizer of NBER workshops: on behavioral finance with Richard Thaler since 1991, and on macroeconomics and individual decision making (behavioral macroeconomics) with George Akerlof since 1994.

Pragcap.com wrote:

The evidence continues to mount against QE.  Mr. Bernanke didn’t see this crisis coming, he responded too late and now he continues to respond with the wrong medicine.  Nonetheless, markets trust his every last move. This debunking comes from noted economist Robert Shiller who says the “wealth effect” from the equity market is “weak” and “not supported in our results”

Below is the full document:

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