Paul Krugman: How to Listen to Financial Markets
Paul Krugman:
The (Nature of) Shock Doctrine: how can you place an interpretation on market movements? What’s the nature of the shock? One way to answer this question would be to ask the traders — although my sense is that really good traders have intuitions that generally go beyond their ability to articulate reasons. Another approach, however, is to look at more than one asset price; if you have a story about what’s driving one price, that story should make sense for the other, too.
Many years ago, when the Fed still claimed to pay attention to targets for monetary aggregates, there was an observable pattern: whenever the money supply came in higher than expected, interest rates rose.... Some people said that rates went up because markets believed rising money supplies heralded future inflation; others, that rates rose because people expected the Fed to tighten to get the money supply back on target.
Jeff Frankel cut through this debate by pointing out that we could look at what happened to the exchange rate. In fact, high money numbers were associated with a rise, not a fall, in the dollar — and this meant that fears of Fed tightening, not fears of inflation, were the real story.
Which brings me to today’s figure: 10-year interest rates versus stock prices.
If fears of default, attacks of the bond vigilantes, were driving rates, a rise in interest rates should be associated with a fall in stock prices — because the change was about bad news. If, on the other hand, it’s about economic optimism — rates rise because people think the US will emerge from the liquidity trap sooner — stocks and rates should move in the same direction.
