What Happens if the Stock Market Collapses?
A collapse of the stock market is defined as a sudden drop in the price of a large number of stocks, usually measured by an index. This collapse can occur over a single day or be spread out of a long period. The effects of a stock market collapse are far-reaching, affecting a country both economically and politically.
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History
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Stock market collapses have occurred periodically throughout U.S. history. The most famous stock market collapse in U.S. history began on "Black Thursday," Oct. 24, 1929, when the Dow Jones Industrial Average fell over 20 percent. The index would eventually lose over 90 percent of its value, helping set off the Great Depression. More recently, in 2007, the Dow reached a peak of over 14,000, only to lose more than half its value in February 2009, in the midst of a national financial crisis.
Short-Term Effects
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The short-term effects of a stock market collapse are a loss of confidence in the financial health of businesses, leading to a potential economic crisis spurred by a cycle of reduced spending and job losses. To prevent this, governments will often work to encourage lending. This can include actions by the central bank to reduce lending rates, as well as efforts by the federal government to prop up faltering businesses.
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Long-Term Effects
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The long-term effects of a stock market collapse can be disastrous. If the value of companies is reduced significantly, this can affect their ability to receive capital necessary to compete or expand. This can lead to a recession in economic growth, causing companies to lay off workers. These layoffs can cause fewer goods and services to be consumed, leading to more layoffs.
Significance
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A prolonged stock market collapse may lead to changes in the leadership of a country, as the policies that led to the crash may be replaced. In the election following the Great Depression, the Republican president was succeeded by the Democratic President Franklin D. Roosevelt, who instituted a wide-ranging series of measures designed to restore the United States to economic health.
Prevention/Solution
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There are a number of different theories as to how a country should repair the damage wrought by a crash. Roosevelt leveraged the power of government to put people back to work. However, others claim that the government should intervene only by creating conditions that will help businesses get back on their feet, such as by lowering taxes or lowering borrowing costs.
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References
- Photo Credit Stock Market Crash image by Paul Heasman from Fotolia.com
