This post is slightly whimsical. I can't decide myself if I'm being totally serious. My argument is certainly less than watertight. But it's not (to me) obviously wrong either. So I'm just throwing it out there.
On average, stocks outperform government bonds. This is called the "Equity Premium". Nobody understands why (yes, we know stocks are riskier than bonds, but that doesn't seem to be enough to explain it). This is called the "Equity Premium Puzzle". (See Brad DeLong and Konstantin Magin (pdf) or Wikipedia for a discussion).
Lets say that the equity premium is around 5% for a ballpark estimate, which is good enough for my purposes here.
"Stock market capitalisation to GDP ratio" is the market value of all equities traded on stock exchanges as a ratio of annual GDP. This ratio varies across time and across countries.
A very quick and dirty Google gives me a ballpark estimate of around 100% for that ratio for advanced countries like Canada. Total stock market capitalisation is around the same size as annual GDP.
Suppose the government could wave a magic wand, make stocks as attractive to hold as government bonds, and abolish the equity premium. Multiplying my two ballpark estimates together, the benefits of waving the magic wand would be worth 5% of GDP, for each and every year the magic wand was waved. That's a big deal. And (assuming my two ballpark estimates are correct) that's a lower bound estimate of the benefits of waving the magic wand. Because if the wand were waved, and the equity premium were abolished, firms would presumably issue more stocks and households would hold more stocks. (Just like if you could wave a wand and make transportation costs disappear, the benefits would exceed current transportation costs, because more goods would be transported unless the supply or demand curves were perfectly inelastic. There's a triangle, as well as a rectangle, between the supply and demand curves.)
All we need is a magic wand.
We have a magic wand. It's monetary policy. All we need to do is have the central bank target the stock market total return index. If the central bank used monetary policy to target the total return index at (say) 7% per year, then anyone investing their savings in that stock market index would be guaranteed a return of 7% each and every year. That's a nominal return, of course, unadjusted for inflation. But it would be exactly the same as buying a government bond earning 7% per year nominal that could be bought or sold at face value any time you felt like it. Both returns would be guaranteed by the government. The stock market index portfolio, and government bonds, would become perfect substitutes. The equity premium would disappear.
Would having monetary policy target the stock market total return index be good for macroeconomic stabilisation? I don't know. But 5% of GDP (lower bound) is a benefit that's not to be sneezed at.
And maybe, just maybe, there would be a lot less bond-finance and bank-finance of investment if we abolished the equity premium, which would reduce the size and probability of financial crises too.
[Brad DeLong's recent post "The Economic Costs of Fear" inspired me to write this one.]
I'm off to buy myself a new canoe, to do my bit to increase Aggregate Demand, and because I deserve it. Back later this weekend.