Advancing a Free Society

Let the Market Work

Saturday, April 7, 2012

Financial markets are in a precarious place, with European banks and sovereign balance sheets in the crosshairs. Bank regulators are increasingly aggressive, and eurozone borrowing costs are rising as the debts of years past come due.

Policy makers are seeing their authority, credibility, and firepower tested. In turn, they are tempted to pursue “financial repression”—suppressing market prices they don’t like. But this is bad policy, not least because it signals diminished faith in the market economy itself.

Markets are not always efficient, but the market-clearing prices for stocks, bonds, currencies, and other assets (like housing) are critical to informing judgments, in good times and bad. Market-determined asset prices often reveal inconvenient truths. But the sooner the truth is revealed, the sooner judgment can be rendered and action taken.

By contrast, government-induced prices send false signals to users and providers of capital. This upsets economic activity and harms market functioning. Markets that rely on governmental participation will turn out to be less enduring indicators of value.

In environments of financial repression, businesses are keener to retrench than recommit their time, energy, and capital to new projects. Trillions of dollars in private capital remain on the sidelines. And the private-sector engine that drives prosperity sputters.

Consider a few recent examples of this policy in practice.

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