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Home Publications Blogs Beat the Press Plunging Global Stock Markets Do Not Show the Dependence of the World Economy on the Fed

Plunging Global Stock Markets Do Not Show the Dependence of the World Economy on the Fed

Friday, 21 June 2013 05:11

Suppose the price of corn plummets. Does that mean that the world economy is going down the tubes?

Well, it could be the result of the collapse of demand in the world economy leading to less demand for all commodities or it may just be the result of a bumper corn crop. The latter would be good news for the world economy even though it would be bad news for farmers who produce lots of corn.

Such is the case with stock markets. Stock markets move up and down all the time often for reasons that have nothing to do with the state of the economy. They also have very little predictive power. The market has more than doubled from its 2010 lows even though growth has averaged a pathetic 2.0 percent over the last three years. 

Their effect on the economy is also limited. Few companies rely on the stock market to raise capital for investment. The main impact of the stock market on the economy is through the wealth effect on consumption. This is usually estimated as being in the range of 3-4 percent. That means a 10 percent run-up in the stock market, which would generate roughly $2 trillion in wealth, would eventually lead to $60-$80 billion in additional annual consumption. (The impact is usually estimated to be felt over a 2-3 year period.) With a multiplier of 1.5 this implies an impact of 0.6-0.7 percentage points of GDP. That is not trivial, but it is hardly the difference between a booming economy and stagnation.

This is why the NYT badly misled readers with a lead sentence in an article that said:

"Tumbling stock, bond and commodity prices around the world are demonstrating just how reliant the global economy has become on the monetary policies of the Federal Reserve."

The movements in markets showed that the markets respond to actions of the Fed. The plunge in stock prices is bad news if you own a lot of stock, just as a plunge in corn prices is bad news if you have lots of corn. It is not necessarily bad news for the economy.

Comments (5)Add Comment
written by kharris, June 21, 2013 7:02
Misleads? Yes. Badly? Eh...

You argue against the NYT's point by arguing narrowly about stocks. The NYT mentions stocks, bonds and commodities. Your point that firms don't raise much capital in the stock market is not true of the bond market. Retained earnings, bond issuance, stock issuance and bank (and bank-like) lending cover just about every source of funding. Assuming firms are net borrowers, the rise in bond yields means reduced retained earnings (all else equal), a higher cost of borrowing through the bond market and very likely a higher cost of borrowing from banks. Your mention of stocks looks highly selective.

The Times is in fact guilty of confusing financial markets with the economy, but your effort to make that point looks a little sneaky.
Be gentle
written by dvdv, June 21, 2013 7:49
The points you make are illuminating, but I think you are overly harsh on the NYT.
the point is what they don't cover
written by Jennifer, June 21, 2013 10:11
Most people think "economy" and "employment" ( i.e. my job or my neighbor's job) but much of the "economy" as measured by things liked the stock market has diverged from what effects most people. It would be more helpful for the NYT to focus on issues directly related to employment and pay-like fact that wages are actually decreasing. www.nationalmemo.com/wages-fall-at-record-pace
written by Peter K., June 21, 2013 10:21
by DeLong and Klein. Better late than never. The Obama era is disappointing.

Accounting Control Frauds
written by Juan, June 22, 2013 8:27
What is amazing is the lack of discussion on the control frauds that occurs every quarter for almost every large company that is listed on the stock exchanges. To meet quarterly numbers, many companies move stock around, regardless of a buyer at the other end of deal. If the product is moved off of the books it is considered sold. This is exactly the kind of thing Lehman Bros did prior to blowing up. Those practices are still ongoing in many corporate boardrooms.

Sure, the stock valuation is important but what is most important is to show you moved assets off your books.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.