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When a person thinks of the stock market the first thing that comes to mind is usually the Great Depression. Although it was not 100% responsible for the depression it did play a large role in it. The market controlling people causes fluctuations. There are 5 main ways in which it affects the economy, and 2 of them revolve around how the investor feels. Those factors plus the 3 others can determine how a market acts and how it impacts the economy.
A common myth about the market is whenever the market is doing well so is the economy and vice versa. That may be true most of the time but the stock market is not the only thing that determines whether the economy is doing good or bad. Tejvon Pettinger, an Oxford graduate and current Economics teacher at Greenes College, wrote a blog on Economics Help on the topic of how the market affects the economy. In his opening paragraph Pettinger states "daily movements in the stock market can also have less impact on the economy than we might imagine. During the great recession of 2009-13, the stock market performed quite strongly." This piece of evidence puts a big hole in most people's viewpoints of the market. There is a saying about the market: "Stock markets have predicted 10 out of the last 3 recessions." I know that saying probably doesn't make sense but look at this example. For starters there was actually a huge one day crash on October 19th 1987 a day known as Black Monday. On this day the Dow lost $500 billion (over 22% of its value) and I bet you've never even heard about this. Do you know why? Because it didn't cause any lasting damage. In fact, it ironically helped us because the U.K cut interest rates in fear of a recession and the low rates caused a boom. As far as actual impacts, Pettinger explains five ways in which the stock market affects the economy:
- Number 1 is known as Wealth effect. What wealth effect explains is that when people lose money on the market, they will become more hesitant to spend money which can contribute to a decrease in consumer spending. However Pettinger states "the effect should not be given too much importance. Often people who buy shares are prepared to lose money." Even though people are prepared to lose money they can still become hesitant to spend money after they lose some.
- The second way is the effect on pensions. Since pension funds invest quite a bit of their funds in the stock market so, if there is a large decrease in share prices then the pension funds lose value.
- The third is actually confidence. Yes, confidence. If people are afraid a recession might happen then stock prices could actually fall. It also works vice versa. In the middle of a recession share prices could increase because investors look forward to a recovery.
- The fourth way is investment. Expanding firms often issue more shares as a cost effective way of borrowing money. However, this process because harder as share prices decline.
- The final way is the Bond Market. There are other markets other than stocks and bonds is one of them. When share prices in the stock market look unappealing more people may choose to invest in bonds. These investments are less risky and offer better returns during times of uncertainty. The market impacts the economy in very different ways. it also impacts people in many different ways. But, the market can't be beat or can it?
