NCPA - National Center for Policy Analysis

Taking Stock of Stock Markets

July 29, 2002

Economists cannot decide what a falling stock market means, if anything at all, according to Bruce Bartlett.

On the one hand, the stock market is presumed to be a forward-looking indicator. Market participants make a bet on whether the economy will be rising in the near future or falling. Consequently, a falling stock market might indicate a fear of recession.

However, there have been many occasions when the stock market fell sharply without a recession following:

  • According to economist Brian Nottage, there have been 15 "bear markets" since 1929.
  • But almost half were not associated with a subsequent recession.
  • For example, the stock market fell sharply in 1987 and 1998 without any meaningful impact on the real economy.

An alternative view is that the stock market may be a poor predictor, but may affect subsequent economic activity on its own. That is, a fall in the stock market may so erode personal wealth that individuals will stop spending. Evidence is not conclusive:

  • Some studies find relatively large effects on spending from changes in wealth, while others find very little.
  • Even those that find large effects reports increases in spending of just 5 to 6 cents for every $1 increase in wealth.

Bartlett argues that 401(k)s affect only retirement behavior, not current consumption. Moreover, for most of the middle class, wealth is primarily in housing. For many people, their homes have increased in value by more than their stocks have fallen (see figure). The primary sufferers of the stock market decline are the wealthy, people unlikely to change current consumption drastically.

The impact of the falling stock market is mainly psychological. When people lose money -- even money they never expected to spend -- they feel bad.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 29, 2002.


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