A: One way the stock market affects the economy is in its role as a supplier of capital for new and expanding businesses. One of the ways companies raise money for growth is by selling stock to the public. If entrepreneurs have an easy time getting capital, they can hire employees and invest in marketing, which helps the economy by creating jobs.
When the market drops, companies have a harder time raising money for growth because investors are less willing to put money into companies. It’s harder for start-ups to go public and for established companies to float secondary stock offerings.
“If you don’t have money to expand, you have to grow slower than if you have free access to money,” says Tom Linzmeier, editor of LivingofftheMarket.com and manager of ZTA Limited Partnership, a hedge fund.
Q: How does the market otherwise affect the economy?
A: Another way is that when the market drops, people stop spending as freely. “As stock prices come down, people lose money. As a result, they become more conservative and spend less. There is both a psychological and a dollar impact on consumers,” Linzmeier says.