Is the Stock Market a Viable Barometer of Economic Health?

The S&P’s record close of 1992.37 on Thursday begs the following question: what, if anything, does a soaring stock market index, up almost 8% just this year, say about the health of the real economy?  As I’ve mentioned previously, there are quite a few issues in the current U.S. economy that may have to be rectified before the real economy can sustain robust growth – a weak labor force and stagnant wage growth, for example.  If we are to interpret the appreciation in the price of a stock market index as a sign of economic health, as many pundits on TV seem to do, then Thursday’s record close seems to contradict what the assertion that wage growth and a robust labor force are vital to the U.S. economy’s health.  This subject is briefly addressed on page 101 of  Freefall by economist Joseph Stiglitz, an account of the financial crisis, its causes, and aftermath.  He says:

“Unfortunately, an increase in stock market prices may not necessarily indicate that all is well.  Stock market prices may rise because the Fed is flooding the world with liquidity, and interest rates are low, so stocks look much better than bonds.  The flood of liquidity coming from the Fed will find some outlet, hopefully leading to more lending to businesses, but it could also result in a mini-asset price or stock market bubble.  Or rising stock market prices may reflect the success of firms in cutting costs – firing workers and lowering wages.  If so, it’s a harbinger of problems for the overall economy.  If workers’ incomes remain weak, so will consumption, which accounts for 70 percent of GDP.” 

I quoted the preceding passage because it cogently argues that stock market gains are not necessarily emblematic of health in the economy, as the media – particularly on business-oriented news shows – often suggest.  The two scenarios Stiglitz mentions (expansionary monetary policy and firms cutting costs) result in higher stock prices but not a healthier economy.  It is erroneous to conclude that the price of the S&P 500 is a sufficient and reliable barometer of economic health.

About schapshow

Math & Statistics graduate who likes gymnastics, 90s alternative music, and statistical modeling. View all posts by schapshow

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