Stock prices, notably those of banks, have been chilled ahead of this week's Federal Reserve meeting on interest rates, leading economists to wonder anew about the market's vulnerability.
Many investors are bracing for a rate hike by Wednesday, perhaps the first of several from the central bank that could modify the trajectory of the economy and prompt a mood swing on Wall Street.
Fed Chairman Alan Greenspan appeared to serve notice in his recent congressional testimony that he saw outsized gains in stock valuations as a source of imbalance in the economy, along with the steadily tightening labor market.
"It was pretty clear that the Fed's staff has been studying the relationship of the stock market to the economy," said Edward Yardeni, chief economist at Deutsche Bank Securities in New York. And perhaps it has concluded that a market slide-even a crash-would not threaten the economy seriously.
Shortening his usual elliptical style, Mr. Greenspan spoke on June 17 of "an unsustainable trend produced by an inclination of households and firms to increase spending on goods and services beyond the gains in their income from production.
"That propensity to spend, in turn, has been spurred by the rise in equity and home prices," he said, "which in our analysis suggests can account for at least 1 percentage point of GDP growth over the past three years."
For some time now, the economy has been expanding nearly 4% per year-on Friday, the Commerce Department reported a 4.3% annual growth rate in the first quarter, up from the 4.1% estimated earlier. The Fed, however, views 3% growth as about the highest sustainable pace for noninflationary growth.
"Even if this period of rapid expansion of capital gains comes to an end shortly," Mr. Greenspan said, "there remains a substantial amount in the pipeline to support outsized increases in consumption for many months into the future."
He then added, "Of course, a dramatic contraction in equity market prices would greatly reduce this backlog of extra spending."
Mr. Yardeni termed this a "zinger," with the central bank head suggesting the worrisome imbalance generated by the stock market's so- called wealth effect would persist unless stock prices fall.
And Mr. Greenspan issued a reminder that, "because monetary policy works with a significant lag, we have to make judgments not only about the current degree of balance in the economy but (also) how the economy is likely to fare a year or more in the future."
The Fed chairman said, "One of the great bull stock markets in American history" has been unfolding. He termed it difficult to assess whether an "unstable bubble" has developed but acknowledged the concerns of "a large number of analysts" that stock prices are excessive.
He then said that though "bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy." Instead, he said, wrong-headed policies are to blame for any trouble.
Japan's current economic problems stem not from the bursting of a market bubble a decade ago, Mr. Greenspan said, but from "subsequent failure to address damage to the financial system in a timely manner." Likewise, the famous 1929 U.S. stock market crash was "destabilizing," but the Great Depression that followed was actually caused by "ensuing failures of policy."
By contrast, the 1987 market crash "left little lasting imprint on the American economy." Mr. Greenspan headed the Fed at that time.