How Does the Stock Market Affect the Economy?

11 November 2016

As the Nasdaq fell in 2000, the overall venture capital investing also decreased from the once “booming” pace that was known through the 1990’s. The declining stock prices affect firms in several ways, as well as impacting their sales to consumers. The rising importance of venture capital for funding growing business will also make it harder quite hard to exactly determine select magnitudes. According to this article, stocks prices do affect firms because they increase shareholder pressure on managers to cut cost and are forced to lay off workers.

When stock prices go down tremendously it affects a firms value of the stock and the stock options. It is unclear whether or not this affects payroll costs and inflation. There is minimal data to prove whether it does or not, but we can say on some scale mainly small it has to. The third factor bringing down the stock prices is them seeming weaker or more uncertain profit outlook which causes investors to demand higher risk premiums which boosts the cost of financing business investment. An additional factor that affects firm’s behavior is Tobin’s q theory of investment.

According to this theory, firms have less incentive to invest in capital if there is a fall in the ratio of q of the cost of buying new capital. Overall in this market stock prices do affect firms from doing more business, employee turnover, and getting investors to continue investing in their business. Next market that may or may not be affected by stock prices is the household sector. One can assume that lower stock prices are correlated with greater uncertainty and lower confidence due to past data and occurrences that cause economists to believe this.

According to this article, “most estimates of stock wealth effects imply that for every $100,000 to decline in stock wealth, annual consumption falls by roughly $3,000 to $5,000 over the long run. ” We can then interpret from this excerpt that yes over the long run less consumers are willing to spend when the Nasdaq decreases remarkably more so than normal which inter does affect the economy. This article also correlates wealth as being the only sector of people that are truly affected by stock prices plummeting.

Article states that stock prices alter people’s expectations of future economic growth whether it’s their own or not. Playing devil’s advocate would be an economist that states 1 to 5 percent of families that stock prices decline are unlikely to affect spending. Maki and Palumbo have concluded by using data across different groups of households, the two new Federal Reserve studies have provided sufficient evidence that stock prices affect consumer spending through a “wealth channel. Our overall opinion on this subject is that stock prices do affect the economy, however not by a substantial amount. The fact of the matter is that people still spend money, and the firms still move on and continue their business, and households are merely enthused. I would say just from personal experience working for a fortune 500 company that whenever the company I work for stocks go down by $5. 00 dollars, no one cares. It’s only when it goes from $95. 00 to $34. 0 that people start to panic and worry about the security of their job.

Of course stock prices are not the only deterrent to a poor economy, many factors are involved and in play that negatively affect our economy. I gather from this article is that is what the author way trying to convey. Yes stock prices do have an influence over the economy, but other occurrences and situations affect it as well. It will be interesting to see as I monitor the stock market more closely how different markets adapt or change if anything at all.

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