NCPA - National Center for Policy Analysis

Stock Market Fall Could Reduce Economic Growth

February 2, 2000

The Dow Jones Industrial Average is down 6.6 percent and the Standard & Poor's 500 index is down 7.4 percent since January 1. Should the market fail to correct itself quickly, economists will mark down their expectations for economic growth this year.

The stock market affects the economy mainly through the so-called wealth effect. Roughly, every $1 increase in stock market wealth boosts consumer spending by 3 to 7 cents, with a common point estimate being 4 cents. A rise in stock market wealth encourages cut backs in saving or increases in debt, and increased consumption. Conversely, a fall causes cut backs in consumption.

  • With household stock ownership over $10 trillion and total consumption at about $6 trillion per year, stock market changes can have a significant impact on economic growth.
  • A new report from the Organization for Economic Cooperation and Development (OECD) estimates a 30 percent stock market drop would shave 0.5 percent off real gross domestic product growth in 2000.

Such a drop would not trigger a recession. It would only lower estimated growth from 3.1 percent to 2.6 percent. Also, the OECD assumes the Federal Reserve would aggressively ease monetary policy.

However, a rising stock market may actually reduce spending. Federal Reserve economist Martha Starr-McCluer reports on a University of Michigan survey that asked shareholders how they responded to increases in their stock market wealth. Eighty-five percent indicated no change in spending or saving, 3.4 percent reported spending more and saving less, but 11.6 percent said a rising stock market encouraged them to save more and spend less.

But those reporting increased spending were concentrated among those with incomes above $250,000, and a recent Bureau of Labor Statistics study found the top 6 percent of households accounted for 14 percent of total spending.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, February 2, 2000.

 

Browse more articles on Economic Issues