Stock market crashes cause major recessions.

Rosnick (2013) has argued that a univariate model provides a better prediction of the unemployment rate than Farmer’s published model. I show here, that although the univariate model provides more accurate out-of-sample forecasts than the VECM, a bivariate model that includes information from the stock market outperforms both alternatives. My results establish that the stock market contains significant information that helps to predict the future unemployment rate. A big stock market crash, in the absence of central bank intervention, will be followed by a major recession one to four quarters later. Further, the connection between changes in the stock market and changes in the unemployment rate has remained structurally stable for seventy years.