Sunday, February 06, 2005

The CEA Forecasts a *Big* Stock Market Crash

February 04, 2005
The CEA Forecasts a *Big* Stock Market Crash
Brad DeLong
For the past several years U.S. stock prices have averaged something like 60 times dividends--a very high multiple compared to the normal 25-30 or so found in U.S. experience. There are three theories as to what is going on: (i) the equity premium has fallen substantially, and so returns on stocks will average significantly less than the 6.5% per year of the past; (ii) economic growth is about to accelerate, and be noticeably faster than standard models suggest; and (iii) the stock market is about to crash.
The fact that economists are forced to choose from among these three options--for there is no fourth way out--has interesting implications for Council of Economic Advisors, "Three Questions About Social Security," February 4, 2005. That memo denies that the equity premium has fallen. It denies that future growth will be fast. And so we have the CEA forecasting a stock market crash....