A new study by UCLA economist Roger Farmer looks at how big stock market crashes affect the real economy, particularly the unemployment rate. By his calculations, the 50% drop in the US stock market from 2007 through 2009 should have driven the unemployment rate to 18% rather than the actual jobless rate peak of 10%. Why didn’t it? Farmer:
There are two reasons for that discrepancy. First, the stock market drop that actually occurred was not a single shock of 30%, followed by a smooth downward decline: it was a sequence of positive and negative shocks. In my view, the stock market recovered, in large part, because of the policy of Quantitative Easing pursued by the Federal Reserve. In the absence of that policy response, I conjecture that the path of unemployment depicted in the simulation is a good forecast of what might otherwise have occurred.
Of course, would the stock market decline have been as severe if the Fed had not engaged in a passive tightening in 2008?