Effects of The Stock Market on the Real Economy

Jinat Jahan Khan

Movements in the stock market have been found to have a major impact on the economy. Changes in share prices can directly affect the real economy. A fall in share prices can lead to an economic crisis. The stock market crash of 1929 which led to the great depression of the 1930s can be cited as an example in this regard. Also, the downfall in stock prices from 2008 to 2009 in the U.S and then subsequently in the whole west created rifts in the real economy which caused the long recession. 

​ However, the stock market doesn’t always work how we imagine. Sometimes daily movements in the share market have no observable impact on the economy. For instance, think about the stock market crash of 1987. The UK was in fear that the crash would ultimately cause a recession. So it cut interest rates, which surprisingly caused an economic boom. Even the collapse in share prices from 2000 to 2004 in the UK did not reflect any serious problem for its real economy. 

 There is a long-standing debate among economists about whether or not the stock markets influence the economy in real. Though there are many arguments on this topic, we can try to sum-up some effects of the stock market on the economy and individual study which conclude that the change in share prices always cannot be a key factor to judge the situation of the economy.
Some economic effects of the stock market:

• Wealth effect:

The wealth effect is a behavioural economic theory which refers to the link between the level of personal wealth and people’s decisions, how much to spend or save on goods and services. During bull markets, they can see their portfolios rise in value which eventually induces them to spend. An increase in the market value of some assets such as gold, bonds, stocks, property induces a feeling of being ‘richer’ in their owners which often tends to encourage spending than saving. And they prefer to spend this money where there is a chance to generate more money. Hence, they find the stock market to be the best place for this purpose.
On the other hand, this increase in share prices indicates a bull stock market, it may not affect the whole economy much as only rich consumers can invest more in this situation. And even if there is a downfall in prices, they can bear short-term losses.

• Effect on business investments:

Stock prices can also affect individual businesses by influencing consumers’ spending and providing the possibility for strong returns on capital costs. When businesses feel that investments can lead to rising market values such as during bull or rising markets, they want to make capital investments. Merger activity tends to increase during these bull markets as business companies can use stock as currency. New and small companies generally take advantage of market optimism to raise some capital investments by issuing shares or even to use stock as leverage to acquire competitors. On the contrary, the scenario during bear markets is simply different. In this situation, companies become less confident and they don’t want to take risks by investing in new infrastructure projects or expansion plans.

• Pension of private sectors:

Private sector workers are not allowed pension at the time of retirement and so they can’t take the benefits of retirement which the government workers enjoy. There are many private pension funds which invest in the stock market. If luck is in their favour and the stock market is in a good situation, the value of pension funds can increase. Therefore, those people who don’t own any share can have some benefits in the stock market through these funds. However, if share prices fall too much, pension funds can struggle to meet their promises and so individuals with private pensions bear a loss.

• Lack of understanding:

Sometimes the stock market brings bad luck for itself because of a fear of a recession or global slowdown which eventually affects consumer confidence. Bad headlines of falling share prices can discourage people from investing more. The stock market crash of 2008-2009 reflected the fall in confidence. The stock market would not have borne much loss, but as it combined with falling house prices, share prices became a discouraging factor for consumers.

• Making other investments interesting:

If there is a fall in share prices and the decline prevails in the stock market for long, people become very reluctant to invest anymore. They find some better investment sectors such as the government bonds or gold. At times of uncertainty in the stock market, these bond markets offer a better return. However, at times bond markets are the reason for the fall in share prices.
 
Though stock markets have some effects on the individual consumers and businesses and as a whole of the economy, it’s not the only factor to affect the economy. Fiscal policy decisions can also be important factors. For instance, large budget deficits can eliminate government investments slow down the economy. Interest rates can also affect it because rising rates indicate higher borrowing costs, restraining economic growth. On the other hand, falling interest rates can stimulate the growth of the economy.
 
The stock market is sometimes very tricky and complicated. Though it is commonly believed that a rising or bull stock market is indicative of a progressive economy, it’s not always true. At times, any inverse situation can also occur. How the stock market influences the economy is a matter of concern after the reckless lending exploits of certain monetary institutions led to the economic recession that occurred just before the turn of the decade. However, the effects of stock on the real economy are still uncertain and need further comprehensive analysis.

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​Jinat Jahan Khan

​Jinat is a 1st-year student at the Department of Economics. She is struggling with her hobbies and Economics and luck doesn’t seem much favourable to her