The stock market and the economy have been in discussion for the past few years. Seeing the market indexes decline by over 30% within a month, an obvious question among people is to understand how the stock market affects the economy.
In this blog, we are going to discuss the effect of rising or falling stock markets on the economy.
Here, you will get to know the impact of the stock market on the economy. Let’s get started:
How Does the Stock Market Affect the Economy?
Rising and falling stock prices can affect many economic factors, such as consumer and corporate confidence, which can have a positive or negative impact on the economy as a whole. Alternatively, various economic conditions can also affect the stock market.
Here are some ways the stock market can affect a country’s economy:
Stock Market Movements
The movement of individual stock prices gives the stock market an unstable character. When stock prices rise or fall, their volatility can have a positive or negative impact on consumers and businesses.
In the event of a bullish or stock price surge, general confidence in the economy increases. People’s spending also increases when they are more optimistic about the market.
More investors are also entering the market, which contributes to the country’s greater economic development.
A long-term decline in the price of stocks, also known as the bear market, has a negative impact on the economy.
People are pessimistic about the economy, and news of falling stock prices can often cause panic.
Few investors enter the market and people tend to invest in low-risk assets, which puts even more pressure on the economy.
Consumption and Wealth Effect
When stock prices rise and a bull market exists, people are confident in market conditions and invest more. They tend to spend more on expensive items like homes and cars. This is also known as the asset effect, where changes in individual income affect their spending behavior and ultimately lead to economic growth.
In a bear market or a fall in stock prices, the asset effect will be negative. When the market is in bear mode, investors notice that their value of investment portfolio goes down and hence it decreases their spending on goods and services.
Needless to say, the decrease of spending of consumers marks a major impact on the economic growth which is a major component of Gross Domestic Product.
Impact on Business Investment
Like consumer spending, business investment also plays a major role in economic growth. A hike in the stock market also makes a positive impact on the businesses as with the aid of it, they make more capital investment because of the high market values.
Many companies issue SME IPO as they find it easy to raise capital which can be useful for further expansion.
This can be done through the sale of shares. There are more mergers and acquisitions during bull markets as they can use the value of their shares to purchase the other companies.
How Does the Stock Market Affect Ordinary People?
Most people who do not own stock are largely unaffected by short-term movements in the stock market. But even ordinary workers are not completely unaffected by the stock market.
1) Pension Funds:
Many private pension funds invest in the stock market. A significant and sustained decline in stock market trading prices can reduce the value of pension funds and reduce retirement pension payments. Similarly, if the stock market is strong, the value of pension funds can increase.
Even if you don’t own the stock, someone with a private retirement plan is likely influencing the stock market.
However, most stocks are owned by the wealthiest 10% of income earners. According to this paper on middle-class wealth, the poorest 90% of income earners own only 7% of total capital. Falling stock prices primarily affect the top 10% of the wealthy.
2) Business Investment:
The stock market can be a source of business investment, such as companies that offer new stock to raise investment funds. This can lead to more work and growth. If banks have limited funding, the stock market can be a source of private funding.
However, the stock market is usually not the first source of funding. Most investments are usually funded through bank loans rather than stock options. The stock market plays a limited role in making investment and employment decisions.
3) Short Term:
Workers and consumers can argue that they may be affected by the short-term nature encouraged by the stock market. Shareholders usually want higher dividends. As a result, listed companies may feel pressured to grow short-term profits.
This can result in cost savings that affect workers (for example, zero contract hours). Alternatively, businesses may want to start collusion that pushes up consumer prices.
UK companies have been argued to be vulnerable in the short term as the stock market plays a larger role in raising companies. Banks are usually interested in the long-term success of a company and actively encourage more investment than maximizing short-term profits.