What's so bad about recession? All those reports about stock markets falling "on fears of recession" give the impression that recession is self-evidently a terrible thing.
But it's not. Robert Lucas once famously estimated (pdf) that the welfare cost of economic fluctuations were minute - a mere one-twentieth of one per cent of consumer spending. This is simply because such fluctuations are small - a fall in GDP of 2% is a deep recession - and the average person just isn't very risk averse so wouldn't pay much to eliminate a small chance of a loss as small as 2%.
Stock markets, however - or at least market reports thereof - tell us Lucas was wrong.
But markets have always been telling us this. As John Quiggin pointed out here (pdf), the very fact that investors require high expected returns to compensate for holding equities suggests that people are somehow more averse to losses than Lucas-style calculations suggest.
But why? One possibility is that we're creatures of habit. Even small losses - on equities or from recession - force us to change our way of life. And tiny changes - a smaller car, going to less fancy restaurants - can disturb us.
Another possibility lies in the fact that recessions don't hit equally. Recessions don't make us all 1% worse off. They make 2% of us 50% worse off as some people lose their jobs and businesses. And because we can't tell in advance who these 2% will be, we all get scared.
What's more, we might think: "I don't want to risk losing money on shares at the same time I lose my job. So I'll stay of of the market."
This might explain why average long-term returns on shares are high; such people need high returns to tempt them to hold shares (though this is controversial - George Constantinides thinks it is significant, but Martin Lettau doesn't).
It might also explain why the stock market falls "on fears of recession" - it's because such thinking looms larger as the prospect of recession increases.
And here's the point. If we had better institutions to pool recession risk - Shiller-type macro markets - these fears would diminish. Share prices would be higher (as more people were willing to buy them) and less sensitive to recession.
In other words, the stock market is suffering this year because financial markets are so woefully incomplete. Shareholders are paying the price for not having adequate markets.
As an entity, society is very hypocritical in bellyaching about recession but doing so little to spread its risks better.
Wouldn't it be a nice idea if financial innovation were used to help ordinary people avoid risks, rather than help egomaniacs become rich?