Saving and Investment

Stock Prices Affect Economic Activity

Princeton University economist Burton G. Malkiel finds strong support for the theory that stock price increases positively affect the rest of the economy in three ways.

  • Higher prices boost people's wealth and thereby encourage consumer spending.

  • They lower the costs of equity capital for businesses and thus increase investments.

  • A booming stock market increases both business and consumer confidence.

While the "wealth effect" so far as consumers are concerned is difficult to measure, economists at Goldman, Sachs & Co. have attempted to quantify the effect of high stock prices on business investment.

  • They estimate the real cost of capital declined by about 24 percent from early 1995 to early 1998.

  • This, in turn, has boosted investment by about 12 percent.

  • The effect of these developments has been to increase the economy's growth rate by four-tenths of a percentage point annually.

Source: Burton G. Malkiel (Princeton), "Wall Street Moves Main Street," Wall Street Journal, June 23, 1998.

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