Wednesday, February 28, 2007

Effects of a falling Stock Market on the Housing Market

Will a falling Stock Market adversely effect the US and UK Housing Market?

With Global Stock Markets suffering their biggest fall for a decade, it is worth considering the economic effect of a fall in stock markets.

First of all it depends on the severity and length of the stock market fall. For example the stock market crash of 25% in 1987 didn’t cause any significant economic problems in the UK or US. Share prices soon recovered and in the UK the late 1980s saw a remarkable period of high economic growth. This was partly because; in response to falling shares, the UK govt cut interest rates and taxes to boost demand. There then followed a rise in economic growth and a rise in house prices.

However other experiences show us that falling share prices can have an adverse effect on the economy. Most notably the great depression was caused by the wall street crash of 1929. What happened in 1929 was that the fall in share prices was so big and prolonged that it caused a general decline in economic confidence and collapse of certain financial institutions. (especially medium sized banks in America) with a fall in confidence, firms reduced investment and consumers reduced incomes. This caused the initial fall in economic growth and rise in unemployment. These effects were magnified by an adverse multiplier effect. As people were made redundant they in turn spent less, causing further falls in AD and economic growth.

Furthermore a fall in share prices causes a fall in consumer wealth. There is a link between wealth and consumer spending. For example rising house prices often increases consumer spending because people can remortgage their houses. However generally wealth held in the form of shares is not directly linked to consumer spending. This is because most people who own shares do not base their consumption on the value of shares. Shares are seen as speculative investment. So even with wild fluctuations in the price it may have little impact on overall consumer spending. (It is also worth noting only a small % of the population have significant savings in shares).

Therefore a fall in share prices won’t necessarily affect the UK housing markets in an adverse way. Consumer spending and growth need not be derailed by a 5% fall in the Dow Jones. However a fall in share prices may make a contribution to a further decline in economic confidence. In America the US housing market is already in decline, with house prices falling. There is also persistent concern about the size of the US current account deficit and levels of debt. Therefore a falling stock market may further undermine economic confidence and make the prospect of a recession in US even more likely.


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