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I’ve long expressed my displeasure with the specific approach implemented by the Bernanke Fed. I am admittedly hard on Dr. Bernanke at times, but I think much of their framework is based on a flawed ideology and misunderstanding of the way the economic machine works. In today’s press conference Q&A Dr. Bernanke said something that I believe confirms this view. Pedro da Costa asked how the transmission mechanism works and why QE is different than trickle down economics since it seems to boost Wall Street, but doesn’t do much else. The Fed Chief answered:

The tools we have involve effecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other rates, I mentioned corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand…if people feel their financial position is better they’ll be more likely to spend…

This is a terribly flawed approach to public policy and it underlines a serious flaw in the way the Central Bank is implementing policy today. What Ben Bernanke just described in the paragraph above is the exact type of thinking that causes enormous distortions in markets and the economy. This sort of thinking is a remnant of efficient market style thinking that assumes asset prices properly reflect the underlying economy at any particular time and totally ignores the reality that Hyman Minsky often discussed, which states that financial markets can become severely distorted by the effects of ponzi finance and financial instability.

The reality of the market is that asset prices do not always properly reflect their underlying values. Asset prices reflect the summation of the decisions of the inefficient participants who are engaged in the buying and selling of those assets. This has been borne out time and time again as irrational human decision making leads people to chase asset prices and underestimate the degree to which stability results in instability. The recent housing bubble and chasing of assets should have made this more than abundantly clear, but myths persist.