Media Panic Over the Stock Market Plunge

The media continue to be in a panic over the drop in the stock market over the last few weeks. Fortunately for political pundits, there is no expectation that they have any clue about the subjects on which they opine.  For those more interested in economics than hysterics, the drop in the market is not a big deal.

The market is at best very loosely related to the economy. It generally rises in recoveries and falls in recessions, but it also has all sorts of movements that are not obviously related to anything in the real economy.

The most famous example of such an erratic movement was the crash in October of 1987. The market fell by more than 20 percent in a single day. There was no obvious event in the economy or politics that explained this fall, which hit markets around the world. Nor did the decline presage a recession. The economy continued to grow at a healthy pace through 1988 and 1989. It didn’t fall into a recession until June of 1990, more than two years later.

There is little reason to believe the recent decline will have any larger impact on the economy than the 1987 crash. As a practical matter, stock prices have almost no impact on investment. The bubble of the late 1990s was the major exception, when companies were directly issuing stock to finance investment.

Stock prices do affect consumption through the wealth effect, but the recent decline is not large enough to have all that much impact. Also, since it was just reversing a sharp run-up in the prior…

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