X. The sociological phenomenon of the stock market in the USA
1. “The wealth effect” and its influence on economy
It is obvious that huge fluctuations of share prices are harmful to economy. Shares not only constitute a significant part of portfolio of many institutional investors such as mutual funds and pension plans but are also bought by individual investors. Although not being money per se, in fact they are treated as its equivalent. As it was mentioned in the introduction, increasing share prices create so called “wealth effect” - people owing them are more willing to spend “real” money for consumption. On the other side, falling prices make people cautious in spending.
The wealth effect is an economic term, referring to an increase in spending that accompanies an increase in perceived wealth. The effect would cause changes in the amounts and distribution of consumer consumption caused by changes in consumer wealth. People should spend more when one of two things is true: when people actually are richer, objectively, or when people perceive themselves to be richer—for example, the assessed value of their home increases, or a stock they own goes up in price.
The conclusion is that increase in consumer spending contribute to raise in GDP and conversely, a decrease in consumers’ willingness of buying goods amounts to lower GDP. In the USA, where over 70% of GDP (more than $10 trillion of the $14.3 trillion) constitutes consumption,[1] that processes are felt particularly. What is more, since the U.S. economy is the world's largest national economy with 24% of nominal global GDP (an estimated 2009 GDP of $14.3 trillion)[2], it is obvious that the violent fluctuations in the US stock market, leading to slump in the US consumer demand, simultaneously ripple through the world’s economy.
2. The role of the government in the economy
Although they are consumers who decide about the condition of the economy, the government also has tools for stabilizing it. It can be done by adjusting spending and tax rates (fiscal policy) or managing the money supply and controlling the use of credit (monetary policy). Fiscal policy that comes under president and the Congress is an unrewarding task since they both realize that higher taxes equal losing support in electoral votes. In turn, spending financed with borrowing money carries specific consequences and must be limited. As a result, the government prefers stimulating economy by monetary policy - controlling the nation's amount of money in circulation trough interest rates. Monetary policy is directed by the nation's central bank, known as the Federal Reserve Board.[3]
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