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in re: Sun Rises, Market Falls

George Bittlingmayer and Thomas Hazlett, the professors whose article I had criticized (“Sun Rises, Market Falls“) for its assertion that the stock market had reacted negatively to the stimulus package, have issued to me a reply of their own. It is reprinted, in full, below. I will have a response to their response in a separate thread.


From: George Bittlingmayer & Thomas Hazlett

Date: 23 Feb. 2009

Re: Response to posted critique

Nate Silver comments on our recent article using the descriptors “stupid” and “unapologetically idiotic,” suggesting that President Obama’s heralded campaign to raise the level of civil discourse is yet a work in progress. We’d like, however, to do our little part in that effort, responding to the substance of Silver’s objections that are not “unapologetically idiotic” but, in our opinion, wrong.

Our article, “The Market is Shorting Obama’s ‘Stimulus,” reported on investor reaction to the recent legislation put forth, and successfully enacted, by the Administration. While macroeconomic intervention anticipated to increase economic growth should be reflected in positive stock returns, we find Dow Jones Index movements generally negative vis-a-vis the stimulus plan. Our take, based on this and other evidence, was that the market is looking for effective reform of the banking sector; stimulus-without-end is at best a distraction and, based on the evidence, a big fat downer.

Silver lodges two objections. First, that the market response may as easily be a verdict that the stimulus was too small as that it was too large. Second, that we cherry-pick our data points and count only DJI downturns, ignoring positive reactions to the stimulus package. On the first point: in theory yes, but in practice unlikely. On the second point: Silver mis-states the positive reaction to Obama policies, which have been (as we stated) a reaction to good news for reform of the financial sector, not to the advance of the Obama “stimulus.” No evidence he cites undermines our conclusion that the fiscal plan has been met with negative movements in the DJI.

Objection 1.
Were the market shorting the stimulus because it was lower than expected our basic conclusion would still be correct: the market is shorting Obama’s stimulus. The “too little” interpretation is implausible, however. First, a substantially larger deficit package would have been unlikely to pass Congress. As it was, the most important news generated following the Obama plan’s introduction was the measure narrowly passed because three Republican Senators endorsed it (and refused to back a filibuster). Market investors would not likely have held expectations that were disappointment by the announcement of a plan that was “too small” when the package was effectively the maximum that could be obtained.

Second, the size of the U.S. plan is extremely large by historical U.S. standards and by current international standards. The Obama plan costs about 4% of 2009 GDP and raises the deficit to about 12%. As noted in our article, this deficit is twice the previous largest in post-WWII American, and far higher than any during the Great Depression of the 1930s. Other leading countries are today much below both levels. The IMF is urging countries to enact stimulus measures equal to 2% of GDP, and having limited success. In terms of 2009 deficits, France is 4.4% of GDP; Germany’s only 3%. It begs credulity to think that investors were expecting the U.S. deficit to exceed international debt financing levels by even larger margins. That a Democratic Party operative says that the greatest danger is in “too little” is fully consistent with this. When advancing a political agenda, one inevitably seeks to undercut the strongest counter-argument. The warning in the WSJ report signals that many were surprised by the scope of the deficit.

Objection 2. As for sample selection, Silver’s post notes that we did not include the Jan. 29 event featuring House passage of the stimulus bill, when the DJI exhibited a large negative return (-2.7% one day return). We excluded this event precisely because its implications were ambiguous. Republicans were unified in opposition; until this point the bipartisan plan was afforded a reasonable chance of success. But, by the same token, the Democrats were almost entirely unanimous in support. This had also been in doubt. We did not count House passage a pro-stimulus event, which would support our conclusion. And we disagree with Silver, who claims that we should count it as a clear anti-stimulus event.

Silver also states that our bias is revealed in omitting the Obama press conference held in Chicago:

And how about November 24th, when Obama rolled out his economic advisory team and prompted the Wall Street Journal headline “Obama Signals Big Stimulus Plan”? Bittlingmayer and Hazlett forget to mention this date. And little wonder why: the Dow had closed up by almost 400 points.

Here Silver misreads our paper. We explicitly take the large positive reaction to the news that Timothy Geithner would be named Treasury Secretary on Friday, Nov. 21, as evidence that the markets favorably viewed the choice. The three-day return for this event includes the 400 point jump on Monday, Nov. 24. That day (Monday, Nov. 24) also featured the official announcement of Geithner and other members of the economic policy team. But the Administration’s stimulus plan had still to be released; neither the WSJ article cited by Silver nor other news reports revealed its size. Indeed, the CBS story that day — Obama Introduces Economic Team – noted:

[Pres. Obama] declined to say how big a spending package he wants to revive the economy, but he said, “It’s going to be costly.” Some Democratic lawmakers are speculating about a two-year measure as large as $700 billion.

The fact that the ultimate magnitude of the plan was considerably under-estimated by the top-end estimate given prior to its announcement is consistent with our view that new information was later revealed. And, when it was, the market reacted negatively.

There is surely room for a friendly exchange on the methods used and the conclusions reached in interpreting stock market reactions to the Obama stimulus plan. We would be happy to have one.

George Bittlingmayer, University of Kansas

Thomas Hazlett, George Mason University