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Market volatility must not guide government policy

A man walks past a screen displaying the Hong Kong stock index's movement at a stockbrokerage firm in Hong Kong on Monday, Oct. 3.

Vincent Yu/Vincent Yu/Associated Press

Politicians and pundits have jumped upon the recent flurry of bad news from financial markets to demand that the federal government "do something" -- although just what that something should be is far from clear.



But no sensible government ever makes policy on the basis of a few bad days or weeks on the market, because financial markets are a notoriously unreliable predictor of the real economy. As the great economist Paul Samuelson once noted, "stock markets have predicted nine of the past five recessions". I don't know when he said this, but I first heard the quote when I was a graduate student 25 years ago, and its applicability seems timeless. To a very great extent, the day-to-day movements in markets are the result of random chance, and attempts to fit them into a narrative aren't always convincing.



The TMX lost half its value in the 2008-09 crisis, and the government intervened massively -- and rightly -- to make sure that financial markets continued to function. On the other hand, the TMX also lost half its value in the wake of the collapse of the dot-com boom in 2000-01, and while the Bank of Canada was obliged to implement a sharp cut in interest rates, the episode hardly registered in the real economy.

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If governments were in the habit of reacting immediately and decisively to movements in financial markets, then we'd have a policy regime that was as volatile as stock markets are. No-one really knows if the recent activity in financial markets represents a 'correction' (things will level off), a 'turning point' (things will get worse) or a 'hiccup' (things will get better).



Right now, the federal government is in neutral: the stimulus package ended six months ago, and the austerity program promised in the last budget is six months away. It seems to me that the sensible course of action is to watch the data from the real economy as it comes in, and revise the policy stance accordingly.



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