Effect of Stock Market Explained

Quite a few people have been asking about the economic effects of falling share prices.

I remember seeing one A Level question asking ‘ Discuss economic effects of a fall in share prices and a fall in house prices’ (15)

Falling share prices will:

  • Reduce consumer wealth for those who own shares. Therefore, they may spend less
  • Reduce value of pension funds and reduce private pension income (if it is a prolonged fall in share prices)
  • Make it more difficult for companies to raise finance on the stock markets, leading to lower investment.
  • Falling share prices tend to reduce consumer confidence.

Therefore, these factors tend to reduce aggregate demand growth and lead to lower rates of economic growth.

However, bear in mind the impact may be limited:

  • Not everyone owns shares.
  • People who own shares tend to be rich and can ‘afford to lose money’ on the stock market. Therefore, their consumption levels will not be affected at all.
  • Stock market crashes don’t always affect levels of economic growth. e.g. 1987 stock market crash didn’t reduce growth at all. (Partly because interest rates were cut sharply)

The impact of falling house prices would be much greater. More people own houses – it is the biggest form of wealth in the UK.

Also, falling share prices are often a reflection of bad economic news rather than the cause.

Related

How Does stock market effect the economy

3 thoughts on “Effect of Stock Market Explained

  1. what i wanted to add is that even the rich can reduce spending if they lost lots of money, for example a rich man may delay buying a new big house because of the losses he made

  2. so would you generally say that, causality is from economic growth to stock market development ?or is it country specific? can there be a bidirectional relationship ?

  3. I think the loss of confidence is the big thing for shares. I feel there is more of a wealth effect on housing.

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