The stock market and economic growth are closely linked as companies rely on borrowed funds or capital investments from owners to expand in response to increased demand. Stock markets provide easy access to funds, but some argue that they can have a negative impact on long-term growth.
Economic growth occurs when production levels increase in response to consumer demand. The stock market and economic growth are inextricably linked because the stock market rises and falls in conjunction with the fortunes of the companies driving the economic expansion. While stock markets serve as useful barometers for people who are attempting to measure growth, some economists even argue that stock markets encourage growth.
Growth normally begins as companies respond to increased demand for goods and supplies by hiring new workers. In order to cover the cost of hiring new employees, companies rely on borrowed funds or capital investments from company owners. Many companies borrow money in the form of long-term debt called bonds, and these instruments can be bought and sold on stock markets around the world. In addition, ownership shares or shares in companies are also bought and sold on the stock markets, and companies raise money by selling lots of shares to investors. The use of bonds and marketable securities to raise capital means that there is a direct connection between a nation’s stock market and economic growth.
In the absence of stock markets, companies have to rely on the company owners using their own savings to finance the company’s expansion or on borrowed funds from financial institutions. Banks finance loans by borrowing money at low interest rates from consumers, and then lending that money at a higher rate to business and consumer borrowers. Traditionally, banks have served as intermediaries in the transfer of funds from savers to borrowers such as expanding corporations. Free-market advocates argue that stock markets eliminate banks as intermediaries, meaning funds can be transferred more efficiently from savers to borrowers. Many economists believe that the relationship between the stock market and economic growth is mutually dependent as easy access to funds allows companies to expand and this stimulates growth.
Critics of free-market economies also acknowledge the connection between the stock market and economic growth, but argue that stock markets can actually have a negative impact on long-term growth. These people believe that investors are less likely to invest in illiquid long-term products such as certificates of deposit (CDs) if they have constant access to highly liquid growth instruments such as stocks. Because banks use cash in CDs and funds of similar types of products to finance mortgages and long-term loans, these banks have to reduce those loans when large numbers of investors move their cash into stocks and other securities. According to some economists, this may make it more difficult to achieve long-term sustainable growth.
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