7:09 am - Thursday June 29, 2017

Stock Markets and Status of Economy

 “It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges” wrote John Maynard Keynes in 1935.

Despite this dig, Keynes also recognized that stock markets enable people with money to invest together with people who can put that investment to productive use.

Globally, capital markets generally exhibit, particularly in the developed and emerging markets, the traits of a ‘more or less’ perfect market with no or ‘acceptable’ entry barriers, large number of buyers and sellers, absence of, or very low, transaction costs, tax parity, and free trading.

And this is only fascinating and facilitating international investors to invest huge sums of money in international markets. To attract such international investments, countries compete with each other and promote their capital markets with savvy sops and policy announcements. It is in fact a reality that no modern economy can exist without an efficient capital market.

Having said that, the debate surrounding the relationship between capital market performance (mainly through share prices or index movements) and macroeconomic growth is still a hotly debated topic among economists, policy makers, and finance professionals.

In the current environment, where increasing integration of the financial markets with capital market reform measures is taking place, the activities in the stock markets and their relationships with the macro economy have assumed significant importance.

Any news about the inflation rate, the rate of economic growth, employment, consumer spending, and other economic variables has significant impact on share prices in general. A given piece of economic news also impacts different sectors within the overall market.

This short note is an attempt to examine the relationship between share prices and the status of the economy. What is the relationship between the health of the real economy and the health of the stock market? Does a rally in share prices reflect better health of the economy or is it the pink economic health that causes share prices to rise?

A causal relationship between the share price index and industrial production can be easily established.

However, it may require time and effort to study and establish interdisciplinary relationships with crucial macroeconomic variables like money supply, credit to the private sector, exchange rate, wholesale price index, and money market rate.

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