How can that not be recessionary?
Actually, lots of ways. But before I get into that, let me cite another smart economist, Jeffrey Frankel, who recently asserted “[r]ecessions are not forecastable. A downturn is no more likely in 2016 than in a typical year, nor less likely.”
There’s another recession out there, but nobody knows where.
Economist Larry Summers recently pointed out that “looking across all major countries over the past several decades, there were 220 instances in which a year of positive growth was followed by one of contraction. In its April forecasts during the growth year, the International Monetary Fund did not anticipate a coming recession on a single occasion!” If that leads you to conclude that weather forecasters are more useful than economists, I won’t argue with you.
That said, consider these distinctions between the equity market and the “real economy,” the latter meaning gross domestic product, jobs, incomes — the stuff most people care most about.
• The ups and downs in the stock market do not correlate with those in the real economy. This is clearly the bottom line. Markets go up and down, and while they tend to tank in recessions, they also tank in non-recessions. But that just raises another question: how could the loss of all that wealth not affect the real economy?
• That depends on the “wealth effect.” When the value of the market falls, investors lose “paper wealth.” That’s not like a decline in your real paycheck. Instead, it’s a loss in the value of an asset that you hold but haven’t yet sold. Unlike your paycheck, such values go up and down every day. However, if they go down and stay down, people do eventually feel less well off, and they may spend less, which will feed back into the real economy. This is the wealth effect, estimated to be around 2-3 percent of the losses. So, if the market doesn’t make back that $1.6 trillion noted above, that could hit consumption to the tune of $40 billion (using a wealth effect of 2.5 percent). But consumer spending in the U.S. economy is $12.4 trillion per year, so we’re talking about a small hit. Still, it’s a hit and it could get bigger if the paper losses grow.
• The stock market doesn’t necessarily invest in the industries that fuel the real economy. Pashtan provides a really interesting table, one I hadn’t seen before, which compares the sectoral weights of the stock market to those of the overall economy. That’s a touch gnarly, so let me explain. The energy sector, which has taken just a merciless beating of late, amounts to under 4 percent of the value of the economy. But stock market investors have 9 percent of their money in energy stocks. So their losses should be disproportionate to the impact on the real economy.
Pashtan’s table (good name for a restaurant!) reveals some correlation between the sectors in which the markets tend to invest and those in the real economy, but they’re far from one-to-one.
• Most people still depend on their paychecks. True, a lot more people own some stock now, though much of that is through retirement accounts. But if you look at who holds the big money in the stock market, it is, as Democratic presidential candidate Bernie Sanders would put it, “millionaires and billionaires.” Data from the Economic Policy Institute reveal that the bottom 80 percent of households hold less than 10 percent of the value of the stock market; the top 10 percent holds 80 percent of the value; the top 1 percent, 35 percent of the value. I recently showed that real weekly earnings of middle-wage earners rose in the past two years (thanks more to low inflation than faster wage growth, but still…). The fact that the income source—paychecks—of working families is doing better than the equity markets is another reason why the market swoon is not obviously recessionary.
It also means that Federal Reserve should keep their feet off the brakes: Employment and wage growth are what’s fueling overall growth right now. Raising rates to slow that down, especially given the marked absence of inflationary pressures, would be a serious policy mistake (if anything, the recent developments spooking the markets, including the tanking of oil prices, is deflationary, not inflationary).
Remember, I’m not saying: “all clear, no recession in sight!” Summers, in the post to which I linked above, believes the markets’ reaction to both China’s slowdown and crashing oil prices are providing an ominous early warning signal: “Because of China’s scale, its potential volatility and the limited room for conventional monetary maneuvers, the global risk to domestic economic performance in the United States, Europe and many emerging markets is as great as any time I can remember.”
Moreover, while I’m somewhat reassured by the table above showing the differences between the economy and the markets, there are interconnections you don’t see in that simple analysis. It’s completely possible for losses in a small but systemically important sector to ripple through the economy, causing way more damage than expected.
So, putting all the above info together, here’s where I think we are. Larry’s point about “limited room” for conventional monetary policy is one I highlighted earlier on these pages. There’s a good chance that by the time the next downturn hits, the Fed won’t have had time to “reload,” i.e., to raise the interest rate they control to a point where lowering it would provide needed monetary stimulus.
Our best policy move is thus analogous to what we and everyone else in my neighborhood appear to be doing: prepare for the blizzard! In economic terms, that means great caution at the Fed in terms of roughing up an already vulnerable economy with unwarranted rate hikes. And given the Fed’s “reload” problem, it means being ready to employ fiscal policy measures, like Unemployment Insurance and other safety net functions, along with job-creating investments in public infrastructure.
That requires a functional Congress.
In other words, if you want to worry about something other than two feet of snow, and something we can actually do something about in an election year, worry about politics. If we can get that right, we might be able to deal with the economy.