Does Congress Only Respond to Fluctuations in the Stock Market?

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Friday, 28 December 2012 08:07

That seems to be the view of the NYT editorial board which concluded a piece on the fiscal standoff by saying:

"But if Congress cannot approve a deal by New Year’s Day, the anticipated sell-off on Wall Street in early January would, one hopes, force House Republicans to budge."

This view, if correct, is truly scary. First, the real impact of failing to come to a deal is the higher taxes and reduced spending which will soon slow growth and raise unemployment if Congress waits too long into 2013 to take action. One might hope that this would be of sufficient concern to get the Republicans in Congress to move.

As far as a sell-off on Wall Street, first it may not come and second, who gives a damn? The stock market has presumably priced in the risk of not seeing a deal by the end of the year. While prices will likely fall further if that risk is realized, those anticipating some sort of double-digit drop are likely to be disappointed.

On the flip side, it would be really scary if folks in Washington are making policy based on the ups and downs of the stock market. The stock market moves in erratic fashion in response to real news and to nothing. What were the events in the world that provided the basis for the 25 percent drop in prices in October of 1987? Was the economy headed for disaster?

Furthermore, even large fluctuations in the market have only a limited impact on the economy. If the market rises (or falls) by 10 percent there will be a very limited impact on investment, as the small portion of firms that rely stock issuance for financing investment will find it easier (or harder) to do so, as well as a modest impact on consumption due to the wealth effect. But even a 10 percent movement hardly implies a boom or recession. If we see the market fall by 3 percent as a result of missing the deadline, which may subsequently reversed, the impact on the economy will be hard to detect.

It would be incredibly irresponsibly to make policy based on stock market fluctuations. If some members of Congress actually base their votes on stock market fluctuations then this would be a great news story. Voters should have this information so that they can replace the current members with more competent policymakers.

 

Thanks to Robert Salzberg for calling this to my attention.