Sharechat Logo

Warning to central bankers to weigh every word used or risk stability

By Michael Coote

Friday 10th September 2004

Text too small?
Central bankers have to guard and weigh every word they utter on policy.

This lesson was brought home sharply to US Federal Reserve chairman Alan Greenspan, when he gave a televised after-dinner speech entitled The Challenge of Central Banking in a Democratic Society on December 5, 1996, argues Yale economics professor Robert Shiller in a short article headlined Definition of Irrational Exuberance -­ Origin of the Term.

Fourteen pages into the lengthy Greenspan speech came, "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"

Bingo! The famous IE phrase was coined. It did no good that the speech continued, "We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability." The caveat was too little, too late.

On December 6, Shiller records, "The stock market in Tokyo, which was open as he gave this speech, fell sharply, and closed down 3%. Hong Kong fell 3%. Then markets in Frankfurt and London fell 4%. The stock market in the US fell 2% at the open of trade."

Never again did Greenspan use the dreaded IE words in public, Shiller says.

That did not stop the good professor himself, whose hugely popular book of the same title helped trigger the tech-wreck and collapse of the US equities markets over 2000-2003.

Words count heavily in determining market mood if sourced from central bankers.

Which makes the recent speech by our own central bank boss, Dr Alan Bollard, delivered to the Property Council of New Zealand and entitled What's Happening in the Property Sector?, so intriguing.

For one matter, the Bollard speech is remarkably similar in overall structure and themes to the original Greenspan speech.

Moreover, Bollard says, "In a bubble, asset prices become disconnected from reasonable expectations of the future earnings of those assets. Markets fail to get prices right. This mis-pricing gets reinforced and exaggerated by herd behaviour or irrational exuberance. Investors convince themselves that someone else will pay even higher prices for the assets in future."

Bollard made these IE comments in a section of his speech about commercial property behaviour back in the 1980s.

Moreover, the property market is not as liquid and therefore not as immediately responsive as the sharemarket to taking fright at what a central bank governor has to say.

But the Bollard remarks are not that dissimilar to the Greenspan comments and are themselves couched in general, not historical terms.

Bollard concluded his speech by stating that, "Like any other asset markets, property markets can get out of kilter with the underlying requirements of the economy and investor preferences can change independently of the economy at large.

"As I have said before, at the margin this may have been the case in parts of the housing market over the past two years, with some investors becoming unrealistic about prospective returns. There are, no doubt, examples of overzealous investors in the commercial and rural property markets too."

Thus we have had our very own IE speech from a central banker, in this case on property.

It remains to be seen if the Greenspan effect strikes through.

  General Finance Advertising    

Comments from our readers

No comments yet

Add your comment:
Your name:
Your email:
Not displayed to the public
Comment:
Comments to Sharechat go through an approval process. Comments which are defamatory, abusive or in some way deemed inappropriate will not be approved. It is allowable to use some form of non-de-plume for your name, however we recommend real email addresses are used. Comments from free email addresses such as Gmail, Yahoo, Hotmail, etc may not be approved.

Related News:

SML - Synlait Milk Limited - Trading Halt of Securities
AIA - Auckland Airport announces board chair changes
AIA - Auckland Airport announces board chair changes
CEN - Tauhara commissioning progress update
FPH initiates voluntary limited recall
March 28th Morning Report
KFL Celebrates 20 Years of Excellence in Investment Mgmt.
SVR - Savor FY24 Earnings Guidance & Change in Banking Partner
NZK - NZ King Salmon Investments Limited FY24 Results
March 27th Morning Report