Why the Fed Should Heed the Market

By Edward P. Lazear. Excerpts:

"market indexes are among the best predictors of growth and employment. Fluctuations in market capitalization also affect consumption"

"Data from the past four decades show that a 10% decrease in the S&P 500 over a period of either three or six months is associated with a decrease of about 0.5 percentage point in the following year’s GDP growth."

"Other useful data include recent GDP growth rates, changes in the unemployment rate, changes in the employment rate, and net job creation. Another factor that correlates with future growth—inversely—is the price of oil: A drop in oil prices of $10 a barrel corresponds to a roughly 0.25-percentage-point boost in GDP growth the following year. But over the past decade, market value has been the indicator most strongly correlated with future growth."

"Job and GDP growth remained positive through February 2008, but the three-month change in the S&P 500 was negative 167 points: a 5-in-100 event. The stock market—not GDP or employment growth—predicted the recession before economists knew it had begun."

"it is the decline in unemployment rather than the unemployment level that signals future growth, and a significant decline is unlikely in the near future."

"The U.S. market has lost about $4 trillion since October. Estimates suggest that the decline will lead to a roughly 5% drop in consumption over the next year, about $200 billion of spending."

"The late 1980s continued to enjoy high growth despite the market decline. The day after Black Monday the Fed cut the target federal-funds rate by 0.5 percentage point, and Chairman Alan Greenspan explained the move: “The Federal Reserve . . . affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”"