Central Bank Equity Purchases: An Idea Whose Time has Come


Writing in the Financial Times last week, BlackRock executive, Rick Rieder, urged the ECB to purchase equities in an attempt to stimulate growth in the Eurozone. Merryn Somerset Webb, disagrees. While Merryn is correct to point out that BlackRock stands to benefit from a policy that would increase equity prices in the Eurozone, that is not a reason to dismiss an idea whose time has come.

Critics of central bank intervention argue that central bank equity purchases ‘distort price signals’? That assumes that private agents interacting in markets are able to accurately divine what is in the best interests of society. In reality, market participants are often captured by waves of optimism or pessimism that are themselves the prime cause of capital misallocations. 

The asset markets are remarkably efficient at allocating capital across industries. They are much less efficient at allocating capital across time. Most of the people we will trade with in the financial markets are not yet born as the shares we buy today derive their value from the actions of our children and our grandchildren. The arguments that economists have provided to explain Adam Smiths’s ‘invisible hand’, rely on the ability of people to trade with each other. As I show in my book Prosperity for All, those arguments break down when applied to the capital markets as a direct consequence of the fact that the unborn cannot buy shares.

Theoretical and empirical research conducted by teams I have led at UCLA, the University of Warwick, NIESR, and the research network, Rebuilding Macroeconomics housed at NIESR, all points in the same direction. The capital markets are socially inefficient. 

The policy implication of our research is that central banks should adopt a policy of active asset price stabilization through targeting the price of an index fund. This policy would be a complement to the traditional monetary policy of interest rate control.

Since the time of Walter Bagheot, economists have recognized a role for central banks in maintaining financial stability. The direct control of the price of an index fund of European share prices would provide an effective way of implementing this financial policy in the European context.