Evan Horowitz is executive director of the Center for State Policy Analysis at Tisch College, Tufts University.
I know the dismissive quips. “The stock market isn’t the economy” and “the market has predicted nine of the past five recessions.” But the roaring stock market of the past few years has been central to economic growth. If the sharp declines continue, it could push the economy into recession — and leave Massachusetts vulnerable.
A key issue is what’s called the “wealth effect,” one of those rare economic ideas that’s mercifully intuitive. When people feel wealthier, they spend more, which drives up retail sales, supports business hiring, and boosts gross domestic product. Just knowing that home values are rising, for example, can make homeowners more likely to take big vacations — even if they’re not actually tapping equity from their homes. Stock prices have a similar effect, loosening the wallets of people comforted by the daily increases in their retirement accounts.
This wealth effect flywheel has helped power the nation’s economy since the dark days of COVID-19, when government checks and expanded unemployment insurance created savings across the economy, including for many workers and middle-class households. But now it’s the higher-income households — with elevated home values and fattened stock portfolios — that are driving consumer spending and bolstering so much US economic activity. According to Moody’s Analytics, the top 10 percent of earners are doing 50 percent of all the spending.
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But the problem with relying on the wealth effect to drive economic growth is that it is fragile. With stock prices having fallen roughly 10 percent since last month’s highs, market professionals and retail investors who can’t bear to look at their shrinking portfolios may start to pare back on their spending. And given that the economy is driven by spending at the top, that could mean a vicious cycle of weak consumer spending, shrinking business sales, and further downward pressure on stock prices.
There could also be spillover effects for businesses, as companies with shrinking sales consider hiring freezes and job cuts. After that, we might see spreading economic anxiety and a nationwide recession, akin to the dynamics that drove the dot-com recession in 2001-2002.
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Of course, that earlier recession was relatively mild, particularly here in Massachusetts, where falling stock prices were quickly balanced by a resurgent real estate market. And it’s possible Massachusetts would be able to ride out any economic trouble in a redux.
Property taxes tend to hold up well in a recession driven by the wealth effect, so city and town finances around the state should be OK. Massachusetts also has $8 billion in its rainy day fund, which would cushion the impact on state finances.
Most important, the Federal Reserve has a lot of recession-fighting firepower. Rapid interest-rate cuts would allow Massachusetts homeowners to refinance their mortgages or apply for home-equity loans, tapping the substantial value of their properties to drive economy-stabilizing household spending.
But there are also reasons to think that a market-driven recession could be a lot worse for Massachusetts this time around, including the uncomfortable fact that helping liberal Massachusetts is not a priority of the Trump administration. It’s conceivable that a stimulus package from Washington could be tilted to provide more aid to redder parts of the country, with limited grants for strongly progressive redoubts like ours, and less support for leading local industries that are already in the crosshairs, including higher education and medical research.
Meanwhile, Massachusetts has also made its tax system more dependent on stock prices via the millionaires tax. About a third of all income among millionaire-earners comes from capital gains, and in a world of falling stock prices, these gains tend to collapse, sometimes for several years. That could decimate a funding stream that is increasingly central for transit investments and education programs.
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And then there’s the central, terrifying risk. For nearly 100 years, the United States has kept recessions in check with timely stimulus actions and evidence-based economic policy. Rarely have the responses been perfect (too little stimulus in the Great Recession, too much inflation after the pandemic), but those are venial sins. If the Trump administration follows its own unproven instincts, who knows how far our economy could fall.
