…Must Come Down

IS THE stock market too high? Years of experience forecasting interest rates and stock prices have taught economists and others that they cannot accurately forecast changes in stock prices, interest rates, and other asset prices. Clever devils that they are, economists developed a robust explanation of their repeated failures, known as the efficient-market theory of asset prices. This theory implies that predictions will do no better than chance. Tossing a coin is as good a predictor of future asset prices as the commentary of your favorite guru.

From personal experience, I know that many people are reluctant to believe this story. Yet there is overwhelming evidence for the idea that well-organized asset markets are efficient processors of information. Whatever is reliably known or believed is reflected in current prices. Most of the time, prices move up or down more or less randomly, affected by such things as the number of buyers and sellers at a particular time. New information about current and future earnings or cash flow causes sustained changes in prices and valuations of individual assets or the whole market.

About the Author

Allan H. Meltzer

Allan H. Meltzer is a professor of political economy at Carnegie Mellon University, a visiting scholar at the American Enterprise Institute, and the author of A History of the Federal Reserve.

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IS THE stock market too high? Years of experience forecasting interest rates and stock prices have taught economists and others that they cannot accurately forecast changes in stock prices, interest rates, and other asset prices. Clever devils that they are, economists developed a robust explanation of their repeated failures, known as the efficient-market theory of asset prices. This theory implies that predictions will do no better than chance. Tossing a coin is as good a predictor of future asset prices as the commentary of your favorite guru.

From personal experience, I know that many people are reluctant to believe this story. Yet there is overwhelming evidence for the idea that well-organized asset markets are efficient processors of information. Whatever is reliably known or believed is reflected in current prices. Most of the time, prices move up or down more or less randomly, affected by such things as the number of buyers and sellers at a particular time. New information about current and future earnings or cash flow causes sustained changes in prices and valuations of individual assets or the whole market.

About the Author

Allan H. Meltzer

Allan H. Meltzer is a professor of political economy at Carnegie Mellon University, a visiting scholar at the American Enterprise Institute, and the author of A History of the Federal Reserve.