Why did the Stock Market drop?

As usual, Paul Krugman offers a clear analysis of the situation the US economy is now in.

Here is a short summary. Unemployment, because it does not measure those no longer looking for work, is 5.2%, about the same as during the Clinton years. But fewer total number of Americans are working, periods of unemployment are longer then in the 90's, and wages are not keeping up with inflation. Job creation is anemic.

So why is the fed increasing interest rates and slowing the economy? Because inflation is pushing the high end of the 2 to 3 percent acceptable range. Oil prices and healthcare price increases as well as the drop in the international value of the dollar (reducing competition and allowing producers to raise prices) are causing the inflation.

So the fed is putting the brakes on our economy. Increased interest rates and more unemployment is preferable to increased inflation. The economy is still increasing, but that is based on consumer spending. If the real estate bubble collapses or there is an oil shortage the causes prices to spike (and oil production is presently pushing the absolute top limits of production) then consumers will cut back spending. Then we are going to have an economic slowdown. With the federal deficit at its current levels, we have no tools left to deal with such an economic shock.

So the investors have decided that the stocks aren't worth as much now as they were before. Too much risk in the future.