How did falling stocks prices contribute to the great depression?

Answer 1

Stock prices are inexorably linked to the performance of the overall economy. When economic activity is severely declining as was the case during the Great Depression companies typically see a decline in both revenues and profits. The current price of a stock is theoretically equal to the present value of future earnings. During periods of declining profits stock prices will fall as investors begin to discount a company's expected stream of future earnings.

Declining stock prices due to lowered profit expectations can accelerate an existing downturn in the economy as companies slash payrolls to reduce costs, and cut or eliminate capital expenditures and/or dividends . Actions that companies must take during a severe economic downturn to survive unfortunately result in reduced income flows to employees and investors who in turn cut spending, resulting in a vicious self perpetuating economic contraction. The reduced income and revenue flows to both consumers and companies will frequently result in a large number of loan defaults which can put the entire banking and credit system at risk. Large losses to banks will typically result in a contraction of credit to borrowers as banks impose harsh credit standards to protect themselves from additional losses. The resulting credit crunch in turn causes further retrenchment by both companies and consumers which perpetuates the cycle of depression. As investors flee stocks for less risky investments prices continue to drop causing a negative wealth effect whereby investors cut spending due to dramatic reductions in net worth due to collapsing stock prices. The Great Depression lasted for over a decade and vexed the best efforts of policy makers to pull the economy out of its downward spiral.

Answer 2

Stock prices are inexorably linked to the performance of the overall economy. When economic activity is severely declining as was the case during the Great Depression companies typically see a decline in both revenues and profits. The current price of a stock is theoretically equal to the present value of future earnings. During periods of declining profits stock prices will fall as investors begin to discount a company's expected stream of future earnings.

Declining stock prices due to lowered profit expectations can accelerate an existing downturn in the economy as companies slash payrolls to reduce costs, and cut or eliminate capital expenditures and/or dividends . Actions that companies must take during a severe economic downturn to survive unfortunately result in reduced income flows to employees and investors who in turn cut spending, resulting in a vicious self perpetuating economic contraction. The reduced income and revenue flows to both consumers and companies will frequently result in a large number of loan defaults which can put the entire banking and credit system at risk. Large losses to banks will typically result in a contraction of credit to borrowers as banks impose harsh credit standards to protect themselves from additional losses. The resulting credit crunch in turn causes further retrenchment by both companies and consumers which perpetuates the cycle of depression. As investors flee stocks for less risky investments prices continue to drop causing a negative wealth effect whereby investors cut spending due to dramatic reductions in net worth due to collapsing stock prices. The Great Depression lasted for over a decade and vexed the best efforts of policy makers to pull the economy out of its downward spiral.