Harbingers of Recessions

There are two views about the relationship between changes in asset prices and business cycles, particularly recessions. One view contends that asset price corrections often precede or coincide with a recession. The 1929 stock market crash and the Great Depression, the early 1990s asset price collapse and the ensuing recession in Japan, and the 2008 global crash in asset prices and the Great Recession are some of the most vivid cases of recessions foreshadowed by asset price corrections. The other view argues that asset prices may fluctuate too widely to be useful predictors of recessions. In theory, there are many reasons why asset price movements could be associated with the business cycle. First, asset prices affect households' net wealth and their ability to borrow, which can have important effects on households' consumption plans. Second, according to standard Tobin's q-theory, investment should move in the same direction as q, which is the ratio of the market value of capital to its replacement cost.