DOW and S&P Index: With Daily Records, is the U.S. Overdue For a Correction?

Recent statements from San Francisco Federal Reserve President John Williams have indicated that the Fed is moving towards decreasing bond purchases in the coming quarters. The effort to decrease in money supply comes in response to the average job growth of over 200,000 over the last six months. Although officials in charge of open market operations of the Fed are planning on decreasing the purchase of securities in the next couple of months, their behavior is conditional based on increasing performance of the economy.

Since the Great Recession in 2007, the unemployment rate average unemployment rate in the United States has steadily fallen from its peak average of 9.3% to the recent average of 8.1% in 2012. According to Bureau of Labor Statistics, the unemployment rate in the month of April continued to decline from previous months to 7.5%. Many experts believe that this reduction in the unemployment rate resulted from the expansionary monetary policy instituted after the recession. Expansionary monetary policy refers to government purchases of securities to increase the money supply and aggregate demand to ultimately decrease the unemployment rate. However, the danger in a focused expansionary monetary policy is the effect that it has on inflation rates. As government purchases of securities increase, inflation rates rise as well, which is the motivation for individuals like John Williams to call for a decreased government presence in open market operations.

As the Dow and S&P are reaching all-time highs each day, the possibilities of a stock bubble created from $85 billion worth of bond purchases per month are cause for concern. A paper titled "Expansionary Monetary Policy Can Create Asset Price Booms" by Michael D. Bordo states that "asset prices rise as a link to the transmission of monetary policy as a whole." Even conservative Austrian economists like Friedrich Hayek and Ludwig Von Mises believed that monetary policy could lead to inflated asset prices. The government's response to the recession has prompted a slow-but-steady turn back to the natural rate of unemployment that individuals like Williams predict will fully return in 2015, but the byproduct of the government bond purchases are inflated stock prices. On Wednesday, the Dow and the S&P hit new record highs despite a predicted slowed period of economic growth, indicating a stock bubble that may pop abruptly.

Williams is upbeat about the future of the United States economy, forecasting GDP growth at around 3.25% next year, right around the historical average. As the Fed eases open market operations, the Dow will be able to see whether their highs are a result of real economic growth or a bubble created by macroeconomic policy. The government will still play a huge part in regulating the money supply, but the market may finally see natural prices.