Warsh & Greenspan Agree: Asset Prices Are Important for Monetary Policy

Kevin Warsh's nomination for the position of Fed chair generated some unease and uncertainty on Wall Street. This wasn't because he was notably dovish or overly hawkish on monetary policy, but because he shares a similar perspective with Greenspan: asset prices are important when considering the economic and financial outcomes of monetary policy decisions.

Greenspan and Warsh approach asset prices from distinct angles. In his well-known "Irrational Exuberance" speech, Greenspan posed the question, "Where do we draw the line on what prices matter?" "Are the stability of these prices (both real and financial assets) crucial to the economy's stability?"

Although Greenspan never formally answered this question, he consistently explored the idea that they were important, as he perceived increasing asset prices as an additional source of consumer spending stimulus that could result in overheating and broader inflation. He used this perspective on asset prices to implement preemptive policy measures to mitigate the potential growth surge from rapidly increasing asset values.

Warsh adopts a more direct approach in assessing monetary policy and asset inflation. According to Warsh, "Inflation risk must always be taken seriously by the institution charged with price stability. The inflation dragon is always present. A central bank that lets its guard down invites bad company. Inflation is a heightened risk when the central bank continues emergency-style policies long after the emergency. Inflation can take the form of higher sustainable asset prices and/or higher prices for a range of goods and services. Inflation results from bad policy, not bad luck."

Warsh's perspective on asset prices poses greater challenges for Wall Street and investors because he directly links rapidly increasing asset prices to an overly easy monetary policy. In contrast, Greenspan does not make the linkage, but only considers rising asset prices as a potential precursor to broader inflation.

Thus, from Warsh's viewpoint, if investors become "irrationally exuberant" due to his policy decision, it would indicate to him that he is on the wrong policy path.