I don’t know exactly why the stock market has been plunging, but this report provides some context:
Boston Mayor Marty Walsh announces libraries closing, construction projects halting
Think about the implication of that report, and the fact that it was treated as an afterthought in the Boston Globe newspaper. In recent days we’ve seen many seemingly extreme announcements being made in one city, and then quickly spread to many others. If construction were to shut down in most American cities, along with the already obvious sharp declines in many other sectors due to social distancing, then it’s hard for me to see how we can avoid a very steep slump in the economy.
The term ‘depression’ is not clearly defined, other than generally being regarded as an unusually bad recession. If the “Great Recession” of 2008-09 had occurred in the 1870s or the 1890s, it certainly would have been called a depression. There’s also an important distinction between a very deep but short slump, like 1920-21, and a more shallow but prolonged slump, like the Great Recession. Of course the 1930s depression was both very deep and very prolonged.
I have no ability to predict the path of the epidemic, and thus won’t attempt to predict the economy over the next few years. But if I had to hazard a guess as to what’s causing the steep slump in stock prices, it would be a growing realization that the US (and other Western countries) would prefer another bad recession of unclear duration to an outcome where several hundred thousand (or more) died of coronavirus. This will lead to a shutdown of a sizable portion of the economy.
READER COMMENTS
Michael Sandifer
Mar 16 2020 at 7:02pm
I use Krugman’s definition of depression, as distinguished from a recession. To paraphrase, he said a recession is when growth is negative, and a depression is when growth stays low for a prolonged period. That’s why I call the period after the Great Recession a depression. I’ve been saying that we never left the depression, and I’m more convinced of that now than ever, given current signals from markets.
The Fed’s reaction function, especially near the zero lower bound, limits both real and nominal GDP growth. I don’t think wage adjustment matters, because the Fed uses internal forecasts to target inflation with assumptions about RGDP potential and NAIRU. Since they consistently underestimate RGDP potential, we remain too far left on the “short-run” aggregate supply curve.
So, it seems to me that markets are telling us that the risk of recession is now very high, as is a depression to follow.
Rajat
Mar 17 2020 at 6:39am
Hasn’t it been Asian countries that have bitten the bullet and shut down their economies for longer term health and economic benefit? Western countries seem to have unwilling to take strong action until their populations have freaked out enough to give them the cover they needed.
Slightly off-topic, but many have been referring to Coronavirus as a negative supply shock that has begotten a negative demand shock. (I think you used the same terminology in your recent podcast with David Beckworth.) Would it be more accurate to say it has been a real shock that has begotten a nominal shock? After all, the real shock has affected demand as much – if not more than – supply. For example, shops, restaurants and hotels in many places are or have until recently been open for business, but functions have been cancelled or else people are just not visiting those venues. I don’t see this as a nominal shock in the sense that if the prices of those goods and services were flexible, people would consume (much) more of them. The shock has been real. What do you think?
Rajat
Mar 17 2020 at 6:41am
I meant to say: I don’t see this as a nominal shock in the sense that if the prices of those goods and services were flexible, people would not consume (much) more of them.
Scott Sumner
Mar 17 2020 at 9:53am
Yes, I think the real/nominal distinction is more useful here. Indeed I think it’s always a more useful framing, but especially now.
Philo
Mar 17 2020 at 10:08am
Suppose the choice really is between (1) no depression but many deaths from the virus, and (2) a depression but not so many deaths from the virus. Even if our preferred metric for ranking these is the number of deaths, it is not clear that (2) is preferable. It will give us fewer deaths directly from the virus, but more deaths from other causes. This is because prosperity saves lives: more wealth means more ability to bring about the conditions we desire, one of which is longer lifespan. But deaths directly from the virus are more “visible” (à la Bastiat’s “seen and not seen”), and so will have an outsized influence on public policy.
Thomas Hutcheson
Mar 17 2020 at 10:44am
The stock market d0es not believe that the Fed intends to prevent a NDGP from falling. At this moment it is probably right. Hopefully it will change policy soon.
The greater the fall in real output, the greater the inflation that the Fed will need to countenance to enforce Say’s Law.
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