Wednesday, March 11, 2009

Nate Silver and the stock market

Nate Silver is a talented statistician, but one of his recent posts makes politics into economics.

Because he is staunchly pro-Democrat, Silver's article attempts to debunk the notion that various Obama moves (stimulus, budget, etc) have caused the massive stock market drops that occur as Obama announces them. His logic is that markets are pretty good at pricing in information beforehand, so the stimulus and budget and such were priced in before Obama announced them. Thus, the stimulus and budget didn't cause the stock market drop, coincidence did.

What Silver is missing is that the market is sometimes very good at pricing in QUALITY EXPECTATIONS information beforehand. If everybody knew the stimulus package was going to pass, but the stimulus package turns out to be in some way worse than expected (which most economists DID think), then the moment of the stimulus' announcement DOES constitute new data. If the market expected Republicans to remove more bad components, or if the market expected Obama to be more budget-conscious, and then the actual package was worse, then the short-term economic outlook DOES change significantly from one second before the stimulus gets announced to the moment the stimulus gets announced.

In fact, you don't even need the stimulus to be bad for it to cause stock market drops. The stimulus was undoubtedly a democratic spending package rather than a short-term-stimulus-optimizing collection of programs. If the market was expecting a mix more heavily weighted to the latter and got the former, simple math means that expected stimulus from the stimulus package falls the moment the details are released. Stock market therefore drops.

Size and date of things like the stimulus and the budget are only roughly correlated with quality of these plans, but all of them are critical in setting economic expectations.

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