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Stock Market Crashes

Aug 19, 2011 • Behavioral Economics, Demand, Supply, and Markets, Economic History, Financial Markets, Households, International Trade and Finance, Thinking Economically • 107 Views    No Comments

How to define a stock market crash? One economic paper has 2 suggestions:

  • “When you see it you know it.”
  • Look at depth and duration: A 20% drop is a crash while length can vary. Several possibilities: 1 day, 5 days, 1 month, 3 months, 1 year.

Suggesting we have undergone 15 major stock market crashes during the 20th century, Professors Mishkin and White say the most drastic 2-day losses were during 1929 and 1987:

  • On October 28, 1929 the Dow fell 12.8% and then, the next day, took another 11.7% slide.
  • For October 19, 1987, the drop was 22.6%.

More recently, the Dow plunged from 11,616 to 6,547 between August 14, 2008 and March 9, 2009.

And that takes us to today. The Dow has tumbled 14% since its April 29 high of 12,810.54 while the S&P has declined 16%.

Perhaps most crucially, Professors Mishkin and White ask whether crashes are consequential. Their answer? For a correct diagnosis of our economic ailments we need to focus on financial instability rather than stock market volatility.

An Economic Lesson

The key difference between 1929 and 1987 was the economy. 1929 marked the beginning of the Great Depression with industrial production plummeting each year from 1930 to 1932 (-8.6%, -6.5%, -13.1%). By contrast, during 1987, the GDP increased 3.2%.

An Economic Question: How might the impact of a stock market crash ripple through the economy?

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