How Does the Stock Market Affect the Economy?

Topics: Economics, Stock market, Investment Pages: 2 (724 words) Published: October 18, 2012
How Does the Stock Market Affect the Economy?
This article examines how the stock prices affect the GDP. “According to the Federal Reserve Board’s model, a 20 percent decline in stock prices lower the GDP by about 1.25% after one year.” For only one year, we can conclude that yes, the stock market in some ways does effect the economy. Many economists agree that stock market affects the economy, while there are still others that think there are many other influences that affect the economy and not just the stock market. 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...
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