I suppose I ought to say something about recent stock market turmoil, even though I don’t have any great insights.  (I recommend John Cochrane’s recent post.)

I generally divide shocks up into two types.  There are negative demand shocks, like 1929 and 2008.  Then there are real shocks, when the market crashes without any big drop in NGDP growth expectations.  That might have been the case in 1987 and 2000, although I’m not certain.

As far as I can tell, the recent market decline seems more like a real shock.  I don’t see any sign of slower NGDP growth expectations.  The Hypermind market is almost unchanged, and there’s not much change in nominal bond yields or TIPS spreads.  If anything, bond yields have risen, which is not reflective of declining NGDP growth expectations.

So if it’s a real shock, then what caused it?  Keep in mind that thus far the decline has been modest, less than 10%.  And that follows a huge stock price run-up.  So don’t look for a huge real shock, merely something that means investors are still quite optimistic, just a bit less optimistic than a week ago.  It’s all about levels.

One possible culprit is an increasing sense that things are “unsustainable”.  Here are a couple areas where that perception may be building:

1.  Perhaps RGDP growth is unsustainable.  Unemployment has fallen to 4.1%, the working age population is growing very slowly, immigration reform seems unlikely, and nominal wage growth is accelerating.  The recent 2.9% wage growth number seemed to hit stocks.

2. Perhaps fiscal policy is unsustainable.  The GOP passed a big tax cut (which will end up costing much more than estimated.)  After you do that, you are supposed to tighten up on spending if you are the small government party.  Instead they basically took off all the restraints on spending.  The deficit is about to get much worse.  And when the next recession hits?  Don’t even think about it.

[Remember when Blair and Brown enacted a big fiscal stimulus at a time when the UK was booming in the early 2000s?  And then there was no money for fiscal stimulus when the Great Recession hit.  That’s basically the current GOP.]

I don’t have a lot of confidence that fear of unsustainable trends is what caused the recent market setback, but I can’t see any other plausible culprits.  Have I missed anything?



30 Responses to “Unsustainable?”

  1. Gravatar of dtoh dtoh
    8. February 2018 at 16:00

    What about fear of Fed incompetence.

  2. Gravatar of dtoh dtoh
    8. February 2018 at 16:09

    Clearly the higher wage numbers is what caused the initial declines. And judging from:

    1) Past Fed incompetence,
    2) The lack of comments from Powell regarding the declines,
    3) Negative comments from Yellen, and
    4) Fed belief is sub two percent trend RDGP;

    I would say the odds of the Fed screwing up again is close to 100%.

    (The only mitigating factor is that there’s a real estate guy in charge, and everybody knows that real estate guys love easy money.)

  3. Gravatar of B Cole B Cole
    8. February 2018 at 16:14

    I think this post is right and also dtoh’s comment.

    We have a Fed selling bonds and run-away borrowing by lobby-controlled Washington DC.

    Interest rates could go higher but with any whiff of recession look for government bonds to go to zero yield.

  4. Gravatar of John John
    8. February 2018 at 17:38

    Stocks are not equal to the macroeconomy. It is entirely possible for stocks to decline on “good” economic news if interest rates increase faster than RGDP growth (Cochrane has that in his post). In that scenario, discount rates/required return rate will rise, causing stocks to fall. The problem is that you’re looking at the wrong variable: variations in discount rates drive stock prices, not variations in future dividend growth. Any fundamental macro explanation needs to focus at discount rates, not future cashflows.

    If higher discount rates cause stocks to fall, you would see a sudden rise in real interest rates. The rise doesn’t have to be very large at all: a few tenths of a percentage point could explain 10% decrease in stock prices! So the question becomes: did yields rise a lot in the last week, and if so, why (macro explanation)? I expect RGDP growth will be higher than trend by a few tenths of a percent in the near future (business cycle plus tax reform), forcing interest rates higher and stock prices lower.

  5. Gravatar of ssumner ssumner
    8. February 2018 at 18:35

    dtoh, Powell should not comment on the stock market. And easy money is the last thing the economy needs now–the bigger danger is that money will be too easy.

  6. Gravatar of Steve F Steve F
    8. February 2018 at 18:45

    Did the Dow begin its decline at about the time that people were talking about the Obama administration’s crimes in a real, tangible way? I recollect that it did. And that reality has been manifesting since.

    I would think that there would be a good deal of uncertainty created by this type of news.

  7. Gravatar of Alec Fahrin Alec Fahrin
    8. February 2018 at 19:02


    Stocks do not fall 10% or more because GDP growth is increasing.

    They fall because the market sees a massive deficit spending boom causing overheating and then an inflationary recession within the next few years.

  8. Gravatar of bill bill
    8. February 2018 at 19:33

    How did the stock sell off line up with the first report that we’d be hitting the debt ceiling sooner than expected?

  9. Gravatar of bill bill
    8. February 2018 at 20:05

    Long term interest rates could rise on fear of deficit unsustainability without positive implications for NGDP growth.

  10. Gravatar of Matthew McOsker Matthew McOsker
    8. February 2018 at 21:48

    Brian Romanchuk’s take, which I suspect is correct. Financial engineering gone wrong.


  11. Gravatar of dtoh dtoh
    8. February 2018 at 22:09

    If the market mistakenly thinks the Fed will tighten, when in fact it is not planning (and should not be) tightening, then Powell should comment on the market,

    The silence suggests that the market’s belief that the Fed will tighten may in fact be correct.

    You prognosis that easy money is inadvisable is based on the presumption that the economy is at full capacity and that trend RGDP growth is sub 2%.

    Separate Question – How much additional inflation should the Fed tolerate in order to get an additional 1% of real growth?

  12. Gravatar of B Cole B Cole
    9. February 2018 at 00:01

    Dtoh: I am not Scott Sumner but I love your last question. I wonder if we can obtain 3% real growth if we are willing to accept 3% inflation. In days of yore (Reagan!) anything under 5% was considered good.

    The peevish fixation on 2% inflation, now elevated to sacred totem status by orthodox macro economists, is actually somewhat recent.

  13. Gravatar of Maurizio Maurizio
    9. February 2018 at 01:14

    Is inflation on target or still below target?

  14. Gravatar of Benjamin Cole Benjamin Cole
    9. February 2018 at 02:42


    “Despite market turbulence, Greece issued a 3 billion euros, seven-year bond with a yield of 3.5%.”

  15. Gravatar of bill bill
    9. February 2018 at 06:01

    I don’t think over the medium and long terms such a trade off exists.

    I do think the Fed could have gotten the economy back to full employment faster if it had risked or allowed some inflationary overshoot.

  16. Gravatar of Harry Chernoff Harry Chernoff
    9. February 2018 at 07:58


    This isn’t about interest rates or dividend discount models, at least not yet. Look at the performance of relatively illiquid preferred stocks, like mortgage REIT preferreds, or preferred stock funds over the past couple of weeks. They are down but much less than the high-flyers, and much less than if this were an interest rate panic.

    These illiquid preferreds appeal to retail investors looking for yield but not large institutions, ETFs, hedge funds, risk-parity funds, momentum traders, or algorithms. The float is too small, the liquidity too low, the bid/ask spreads too wide, and bid/ask sizes too small. These stocks also have plenty of duration so that if the declines were about interest rates and the retail crowd was spooked, it would show up here. It certainly did in 2007-2008. It hasn’t this time, at least not yet.

    My opinion is that the selling is a combination of overly complacent FOMO money pouring in to large, liquid, high-profile ETFs (where low-cost was assumed to mean low-risk and stocks only go up), hair trigger algorithms, momentum trading, risk-parity funds, and so on.

    Add leverage, some idiosyncratic match to light the flame (in this case, too much short VIX positioning) and off we go. Sell stops kick in, risk-parity funds reverse or delever, ETFs become forced sellers, and so on.

    For a much smaller subset of investors it’s rational expectations about the effect of three rate hikes this year and three rate hikes next year. Either the yield curve inverts or the 10-yr is 3.25-3.5 at the end of 2018 and above 4.0 at the end of 2019. Then a DDM approach and John Cochrane’s argument kicks in with a vengeance. We’re not there yet but the stock market is a discounting mechanism and some of us may believe the Fed this time.

  17. Gravatar of Rodrigo Rodrigo
    9. February 2018 at 08:07


    Do you believe this move in the market to be a re-pricing of equities to a higher rate enviroment? Or could it be the market fears the fed will raise rates faster than they should due to the recent inflation number? Your thoughts are much apreciated.

  18. Gravatar of flow5 flow5
    9. February 2018 at 11:19

    “If anything, bond yields have risen, which is not reflective of declining NGDP growth expectations.”

    Interest rates may respond to influences other than inflation rates, either current or expected, as there is a demand side factor (government deficit financing) operating in the loan funds market as well as supply side factors

  19. Gravatar of flow5 flow5
    9. February 2018 at 11:25

    “According to the elementary logic of the so-called equation of exchange, any change in either the supply of or demand for money , to the extent that the change is not immediately and fully reflected in an (equilibrating) change in the price level, will imply changed values of real output and employment.”

    To quote economist John Gurley, ‘Money is a veil, but when the veil flutters, real output sputters’.

    “Moreover, because monetary disequilibrium also involves a distortion of relative prices, its real effects are not limited to mere alterations in total quantities of output and employment but also involve qualitative changes in the composition of each, to the detriment of all-around well-being.”

    “All of this suggests that well-designed monetary arrangements and policies are important to the success of any free-market economic system.”

    GDP (NOW): Latest forecast: 4.0 percent — February 6, 2018 vs. 2.6 percent in the 4th qtr. 2017.

    “Neutrality of money means that money is neutral in its effect on the economy. A change in the money stock can have no long-run influences on the level of real output, employment, rate of interest, or the composition of final output. The only lasting impact of a change in the money stock is to alter the general price level.”

    “The neutrality of money theory is a core belief of classical economics. It was first proposed by David Hume (1711-1776). And the phrase: “neutrality of money” was coined by Austrian economist F.A. Hayek in 1931.

    Nobel Laureate Dr. Milton Friedman “gave the example of the (neutrality of money) ‘helicopter drop’ to explain the neutrality of money. Imagine a community in perfect economic equilibrium, when suddenly the following occurs:

    “Let us suppose, then, that one day a helicopter flies over our hypothetical long-stationary community and drops additional money from the sky equal to the amount already in circulation-say, $2,000 per representative individual who earns $20,000 a year in income.”
    ”The money will, of course, be hastily collected by members of the community. Let us suppose further that everyone is convinced this event is unique and will never be repeated….”
    “…People’s attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services. The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available.”
    ”They alter no tastes….the final equilibrium will be a nominal income of $40,000 per representative individual instead of $20,000, with precisely the same flow of real goods and services as before.”

    No, money flows, the rate of expenditures, are robust (as concentrations and distributed lags that are mathematical constants clearly demonstrate), not neutral, as hypothesized and mathematically modeled by Bankrupt-u-Bernanke (Brookings Institution), in either the short-run or long run.

    See: January 2004 “Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach” – with Jean Boivin, Piotr Eliasz: w10220
    “Measuring The Effects Of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach,” Quarterly Journal of Economics, 2005, v120(1,Feb), 387-422.

    Leastways, the neutrality of money is denigrated by secular strangulation. I.e., the quantity of money does not just: “determine only absolute prices and their level” but does affect the level of income, interest, rate of capital formation and employment. No, the long-term effect of a deceleration in aggregate demand has a long-term impact on the demand for capital goods.

    See: See: “profit or Loss from Time Deposit Bank” in Banking and Monetary Studies Comptroller of the Currency Unites States Treasury Department, Irwin, 1963, pp. 369-386.

    Money flows do impact “employment, income and output by means other than by just “labour, capital stock, state of technology, availability of natural resources, saving habits of the people, and so on”.

    No, money flows may simply adjust existing overstocked inventory levels (e.g., during the X-mas holidays). David Beckworth: “What makes this really interesting is that these wide swings in economic activity are not matched by similarly-sized swings in the price level.” “Macro and Other Market Musings”: “It seems, then, that more could be learned about broader business cycle theory from studying GDP and other time series in their raw non-seasonally adjusted form. That will have to wait, however, until the BEA starts releasing the data.”

    See: http://bit.ly/2BQgF4z

    Money obviously influences R *, the “equilibrium rate of interest” (and not just because the monetary fulcrum of wedged inflation inverts). A change in M does not cause a proportionate change in P in American Yale Professor Irving Fisher’s truistic “equation of exchange”. Shifts in the money supply do not affect all goods and services proportionately.

    See the 10yr:


    There is obviously “money illusion” as well as shifts in the distribution of income: “the central feature of the modern business cycle: a systematic relation between the rate of change in nominal prices and the level of real output. The relationship, essentially a variant of the well-known Phillips curve, is derived within a framework from which all forms of “money illusion” are rigorously excluded: all prices are market clearing, all agents behave optimally in light of their objectives and expectations, and expectations are formed optimally.

    Even with a mis-named “liquidity trap”, idled money exerts a dampening economic impact.

    Next, the pundits will say that money velocity, which fluctuates 3 X’s that of M, is neutral.

  20. Gravatar of John John
    9. February 2018 at 11:30

    Alec: where is the inflation in TIPS showing up? Inflation expectations are hovering steady around 1.9%/year ever since the beginning of the year. There is no inflation in our near future, because the Fed will probably restrain rates, as Professor Sumner has pointed out.

  21. Gravatar of flow5 flow5
    9. February 2018 at 11:35

    One of the weaknesses of Professor Irving Fisher’s formulation is that many transactions are effected on a “deferred payment” basis involving no immediate creation or transfer of money.

    This shows up as a spike in payments in January (a seasonal spike in money flows). That’s why, if the market should be sold short, you enter positions in approximately the 3rd week in January. But this year the spike, based on the distributed lag effect, appears to be in December.
    Dec 28, 2017. 07:53 PMLink
    The best time to sell short is approximately the 3rd week in January.
    Dec 22, 2017. 05:07 PMLink

    Money and Money flows, volume X’s velocity,, are robust, not neutral as Bankrupt-u-Bernanke and the NeoFisherians, e.g., John Cochrane claim.

  22. Gravatar of flow5 flow5
    9. February 2018 at 11:40

    Stocks most likely bottomed today.

    It’s just a seasonally exaggerated move. The next inflection point is mid-Feb (c. the 14th). Moves up prior to that date would indicate market strength (higher R-gDp), and vice versa.
    Since inflation peaks in Feb. the market will eventually continue higher.
    Feb 6, 2018. 10:44 AMLink

  23. Gravatar of Alec Fahrin Alec Fahrin
    9. February 2018 at 11:41

    I believe this is a sign that we are late cycle, like in 2006 or 1999. Gonna watch the yield curve closely.

  24. Gravatar of Alec Fahrin Alec Fahrin
    9. February 2018 at 11:43


    If the Fed is doing its job, it will raise rates when its see inflation expectations increase, and continue to until those expectations stabilize around their target (be it lower than 2% or actually 2%).

    Hence, the market is taking this as a sign that monetary tightening is about to begin in earnest.

  25. Gravatar of flow5 flow5
    9. February 2018 at 11:49

    “Hence, the market is taking this as a sign that monetary tightening is about to begin in earnest.”

    Inflation peaks this month. There’s no need to “tighten”.

  26. Gravatar of Carl Carl
    9. February 2018 at 12:03

    I have a hard time believing it’s because “fiscal policy is unsustainable”. It’s been unsustainable for decades.

  27. Gravatar of Brian Brian
    9. February 2018 at 15:02

    I agree with our blog host that the concern of the moment is that RGDP growth is unsustainable. The productivity component is hard to measure when much output is intangible but the workforce is easier to measure. Every time the Democratic party makes a deal with the GOP that doesn’t improve the outlook for immigration and DACA, it exposes Dem weakness and the public’s indifference. Lack of progress on immigration and recent news of wage increases increased inflation expectations. TIPS implied inflation increased steadily from June 2017 to February 2nd 2018, as measured at the 10 year maturity.

  28. Gravatar of foosion foosion
    10. February 2018 at 03:17

    The precipitating event for the current decline appears to be reports of rising wages.

    Rising wages reduce corporate profits (at least as an initial step), which is bad for stocks.

    Rising wages tend to lead the Fed to tighten, which is bad for stocks.

  29. Gravatar of ssumner ssumner
    10. February 2018 at 07:56

    dtoh, You said:

    “You prognosis that easy money is inadvisable is based on the presumption that the economy is at full capacity and that trend RGDP growth is sub 2%.”

    No it isn’t. RGDP should play no role in Fed policy, it’s not a part of their mandate.

    Maurizio, I believe inflation expectations are on target.

    Rodrigo, I don’t think the market is concerned about tight money, but they probably are concerned about rising interest rates.

  30. Gravatar of James Alexander James Alexander
    10. February 2018 at 11:05

    Earnings (and sales) growth is unexpectedly strong in the current season, boosting stocks. They overran and have now corrected somewhat. It all happens very fast. But is “small potatoes”.

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