The relationship between stock markets and economic development Essay

The relationship between stock markets and economic development - Essay Example Empirical studies do suggest that a well developed stock market can considerably support economic growth in the long run through faster capital accumulation, improved resources allocation and exploiting the prevalence of positive sentiment across the country. (Ahmed, Ali & Shahbaz, 2008) In 19th and 20th centuries, academicians such as Bagehot (1873) and Schumpeter (1911) had focused on contribution of financial sector to economy. The main function of money or capital in the initial years was to trade in credit for the purpose of financing development before the Great Depression. Gurley and Shaw (1955) were the first to study the relationship between financial markets and real activity. However, the direct relationship was not very clear until recently. Recent literature has paid much attention to banking reforms which directly affected both the stock markets and economic growth relationships. Levine (1997) suggested that liquid market spread can lead to stable and long term investments leading to economic growth through reduced transaction expenditure. While the conventional economists always believed that there was no direct relation between stock market growth and economic growth because of presence of level effect and not the rate effect. Many of them in fact be lieved that stock markets actually harm the economic growth due to its volatile nature, market flexibility due to unstructured and unexplainable sentiments and generally no justification for sudden surge or fall in stock indexes leading to perceived gains and losses of millions of dollars in a fraction of a day. However, there has been considerable growth of stock market share in economic direction of a country. During late 90s over a period of a decade, the total value of world’s stock markets rose from $4.7 trillion to $15.2 trillion while capitalisation share jumped fro 4% to 13%. (Levine 1998). The figures have since seen exponential growth in the past decade too, with world economy growing