Correlation between Stock Market and Economic Growth - Report Example

The stock markets in modern era are a common feature of the modern economy and are known to perform necessary functions that promote the growth and the development of the economy. Among other factors stock markets dictate income levels in the economy, macroeconomic stability, stock market liquidity, gross domestic product per capita, fiscal policy domestic credit from banks, and exchange rate volatility. Therefore, stock markets are an important tool for macroeconomic market analysis and more importantly, useful in articulating macroeconomic environment. Correlation between Stock Market and Economic Growth Economists have long been associated with mobilizing resources for economic growth and development. Due to this, economists are considered central figures to the growth and the development of a country and they are given the mandate to mobilize resources, savings, and investments for economic prosperity of a country. In order for economic growth and development to be achieved, there is need to effectively mobilize funds and resources and effectively allocated to facilitate businesses and the economy harnessed their human, material, and organization resources for optimum output (Rabiul, 3-5). The bourse is an economic establishment, which stimulates efficiency in capital formation and allocation. It also enables the governments and the businesses to raise long-term capital for invest in new ventures, increasing, and modernizing industrial or commercial concerns of a country. Capital resources needs to be provided to these economic areas, such as industries experiencing a large economic growth, and which are capable of increasing the level of productivity and in the country so that it can maintain the level of economic growth in the country. One of the unique benefits to the stock market is the provision of long-term, non-debt financial capital that are usually associated with the industries ion the countries. Through the issuance of capital securities, businesses acquire continuous capital meant for growth and development. Through the issuance of these types of capital, the market also facilitates businesses to avoid over-reliance on debt financing, therefore improving corporate debt-to-equity ratio. Previous researches have shown that developed countries had come up with two techniques through which resources utilization touches economic growth and development. They were identified as money and capital markets. This markets form the pillar of the stock exchange. However, this case is different in developing countries whereby there is more emphasis put the money market and little emphasis put on the capital markets. To determine the level of involvement of the stock exchange in the growth of any economy, we are going to look at various issues surrounding market development (Zervos a & Levine a, 8). Income Levels in the Economy Basing our argument on the demand driven hypothesis, we realize that the increase in the levels of income of individuals in a country will spur more economic growth. This is because it will increase the demand for more financial services such as baking, investment, consultancy services, and monetary trade. However, the income levels of individuals in a country do not necessarily affect the performance level of the stock exchange. Because of the high levels of intermediation through this stock exchange causes higher real income growth. This in turn promotes development in the stock market. When the levels of income increase, it spurs a cyclical growth in the stock market and the markets price index. Moreover, due to the high levels of income, more impacts will be felt in the property markets of the country experiencing increased income levels. In addition, with better education and better general environment for doing business will spur growth in the stock market (Zervos b & Levine b, 14-16). Macroeconomic Stability Macroeconomic stability has been known to exert pressure on the level of economic growth of a country and on the stock exchange of the country. However, there is no real relationship on the nature and its effects. For instance, macroeconomic instability has been found to have a negative relationship with the level of capitalization in the stock exchange. There is also a non-linear relationship between the level of inflation in a country and the level of equity, market development in the same country. This non-linear relationship shows that as the level of inflation increases, the level of marginal impact on the stock market development decreases rapidly. However, there is no important relationship between inflation and stock market development. Higher levels of macroeconomic stability encourage investors to take part in the stock market hugely due to the predictability of the stock exchange. The level of macroeconomic stability in a country plays a major role in influencing the level of profitability of an investment and therefore the price of securities in an investment will likely increase. This means the investors whose investments are experiencing a capital gain are more likely to invest their savings to the stock market, through increasing their investments. This will increases the level of activity in the stock market of the country and hence the economic development in the country (Binswanger, 244). Stock Market Liquidity Liquidity is the ease and speed at which the economic agents in a country buy and sell equities in a stock exchange. The level of liquidity in the stock markets gives access to the investors to their savings therefore boosting the level of confidence in the stock market investment. This means that the more liquid the stock market, the larger the amount of investment savings which are channeled through the stock market. This will enhance the development of the market. It also means that with a liquid stock market, investors will keep hold of their investments during the cause of their trade in the bourse. This is because they can liquidate their investments’ easily, quickly and at a cheaper cost (Rabiul, 3-5). Gross Domestic Product Per Capita Stock market growth is affected by amount of economic development in a country. While effective capital market adds to economic development, the growth of capital markets incomes increases stages. Therefore, the level of economic development may give a decree to develop a certain feature of capital markets custom-made to the distinct country‘s economic and financial situation. For example, a state in an early phase of economic development may not have instant need for deep and liquid bond markets. It might emphasis further on developing its banking system and capital market. Conversely, a state with a small number of listed companies will not probably want a corporate bond market, but somewhat focus on government bond market development (Campos, Randall & Hanousek, 9). Fiscal policy Monetary policy can have a financial impact on the bond market development in more than a few ways. A country that operates on budget deficits has a higher need for selling government bonds to raise needed funds compared to a country with a budget surplus. A finely honed government bond market is influential to the growth of corporate bond market since it assists to uphold a class of energetic, profitable fixed-income traders. This means that public-sector shortfalls may indirectly have financial impact corporate bond market growth. Conversely, a higher supply of government securities may hide out private debt securities, decelerating corporate bond market expansion (Campos, Randall & Hanousek, 9). Domestic Credit from Banks The banking industry has formed a habit of competing with the bond market in the supplying of external financial requirements to the economy of the country. This means that well established finance organizations can challenge the developing bond market. On the other hand, banks may serve as traders and market creators in the bond market, so the growth of banks and bond markets goes together. Exchange Rate Volatility Superior exchange rate elasticity is both good and bad for local bond market growth. This means that foreign investors’ involvement is valuable to the growth of local capital markets, great foreign exchange peril may discourage foreign investor partaking. In dissimilarity, if fixed exchange rates embolden foreign lenders to undervalue the hazards of lending to indigenous banks and firms, then the subsequent foreign antagonism may slow growth of the indigenous financial intermediation market (Binswanger, 244). Bibliography Binswanger, Mathias . Stock markets, speculative bubbles and economic growth: new dimensions in the co-evolution of real and financial markets. New York: E. Elgar, 2009. P. 240-250 Campos, Nauro , Filer Randall & Jan, Hanousek. Do Stock Markets Promote Economic Growth? Michigan: The University of Michigan, 2005. P. 7-12 Rabiul, Md. "Banks, Stock Markets and Economic Growth: Evidence from Selected Developing Countries." Decision 37.3 (2010): 5-29. ABI/INFORM Complete. 28 Oct. 2012 Zervos a, Sara & Ross a, Levine. "Stock Markets, Banks, and Economic Growth, Issue 1690." Policy research working papers Stock Markets, Banks, and Economic Growth (1996): 34. Zervos b, Sara & Ross b, Levine "Stock Markets, Banks, and Economic Growth." The American Economic Review 88.3 (1998): 537-58. ABI/INFORM Complete. Web. 30 Oct. 2012. Read More