Since mid-September $5 trillion (£3.9 trillion) has been wiped off the value of US shares, prompting the question: how much impact will this have on the US economy?
Of course, the losses are not wholly borne by Americans: over a quarter of US equities are owned by foreigners. Nevertheless, Americans are $3.6 trillion poorer than they were in the autumn. This must do some harm.
Yale University’s Robert Shiller and colleagues have estimated how much. They’ve calculated that each 10 per cent fall in stock market wealth reduces consumer spending by 0.4 per cent. This implies that the fall since September will eventually wipe 0.7 per cent off spending. That’s equivalent to just under half a per cent of GDP.
You might think this is an overestimate. September’s wealth – we now know – was funny money, based upon bubbly share price valuations. History tells us that when bubbles burst the impact upon the economy can be smaller than expected. The economy grew strongly in 1988 after the stock market crash, for example. And the near-$7 trillion stock market losses during the bursting of the tech bubble in 2000-03 led to only the very mildest of recessions.
These precedents, however, might be a false comfort. For one thing, the economy held up well after those stock market falls, in part because the Fed cut interest rates – something it is not doing now (at least not yet). And for another, the link between the stock market and the real economy is not confined to wealth effects.
Quite simply, the mood on Wall Street is often matched by that in boardrooms: this shouldn’t be surprising as fund managers and corporate bosses have similar backgrounds and social circles. A decline in animal spirits on Wall Street might therefore be a sign of a decline in them among bosses.
If this is the case, then it might lead to less hiring. Roger Farmer at the National Institute for Economic and Social Research, has shown that variations in share prices lead to fluctuations in employment. He says: “The ups and downs of the stock market are followed by ups and downs in employment.”
They can also lead to variations in capital spending. This isn’t because lower share prices raise the cost of capital: most capital spending is not financed by equity issues. It’s simply because the lower profit expectations of investors can be shared by corporate decision-makers, which is a reason for them to cut capital spending. In the same way, lower prices can lead to less innovation generally simply because weaker animal spirits depress both. Researchers such as New York University’s Mark Gertler and Carleton University’s Christopher Gunn have found that lower share prices lead to lower productivity growth.
None of this is to say that a recession is imminent. Consumer spending is in large part a matter of habit, and habits are slow to change. There is still plenty of momentum behind the US economy. And it’s possible that share prices and animal spirits will bounce back to some degree. Nevertheless, prospects for the economy are less good now than they were a few months ago. You’d not guess from the wild gyrations in share prices, but there is a middle path between panic and complacency.
