The Stock Market is Relevant

Professor Barro uses historical data on stock market crashes and depressions to predict the probability of a depression.

I agree with him that the stock market is relevant. In particular, the stock market drop of 2009 (sic) is particularly concerning to me in terms of what it anticipates in terms of economic growth going forward.

Professor Barro treats all stock market changes the same (more specifically, he assumes that the fundamentals driving the current crash are equal to the average of the fundamentals driving historical crashes). Given that we know some of the details of this recession, I don't think economic theory justifies his assumption. Some shocks, such as productivity shocks, should lower both economic growth and stock prices.

However, other shocks push economic growth and the stock market it opposite directions. One of those shocks is an increase in the supply of business investment, which I think is highly relevant in today's recession due to the fact that it began with the end of a housing boom that was competing so hard with business investment. For this reason, the crash of 2008 did not bother me.

The crash of 2009 is more worrisome, because it could well anticipate poor productivity in the future. So far productivity has been good in this recession, but 2009's stock market could well see that changing.

There is a third possibility: the 2009 crash is due to a shock like the anticipation of a dividend tax that directly harms stockholders but may have little effect on economic growth. I guess that's bad news itself: we would hope for option three!