In his outstanding new Macroeconomics textbook, Brad DeLong characterizes the equilibrium exchange rate as being determined in part by what he calls the "fear-greed factor." The idea is that expected returns on assets may be higher in a foreign country, but your willingness to buy those assets depends on your greed for higher returns as balanced by a fear that something will go wrong.
In the United States, the locus of the fear-greed factor is the stock market. When greed is dominant, investors are worried about missing out on gains. When fear is dominant, investors are worried about losses.
Although economic performance has been weak this year, the fall-off is not nearly as sharp as the drop in the stock market. Moreover, the decline in interest rates should have offset some, if not all, of the effect of slower economic activity on the value of share prices.
To what would you attribute the large decline in U.S. stock prices over the past two years? In my opinion, it has to be a shift in the fear-greed factor. Greed was potent in the late 1990's, and fear has gained potency since early 2000.
Discussion Question. DeLong attributes some international financial crises to shifts in the greed-fear factor. Could the United States suffer a financial crisis merely on the basis of shifts in attitudes about risk?
