NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Macroeconomics and Finance: The Role of the Stock Market

Stanley Fischer, Robert C. Merton

NBER Working Paper No. 1291 (Also Reprint No. r0594)
Issued in April 1985
NBER Program(s):   EFG

The treatment of the stock market in finance and macroeconomics exemplifies many of the important differences in perspective between the two fields. In finance, the stock market is the single most important market with respect to corporate investment decisions. In contrast, macroeconomic modelling and policy discussion assign a relatively minor role to the stockmarket in investment decisions. This paper explores four possible explanations for this neglect and concludes that macro analysis should give more attention to the stock market. Despite the frequent jibe that "the stockmarket has forecast ten of the last six recessions," the stock market is in fact a good predictor of the business cycle and the components of GNP. We examine the relative importance of the required return on equity compared with the interest rate in the determination of the cost of capital, and hence,investment. In this connection, we review the empirical success of the Q theory of investment which relates investment to stock market evaluations of firms. One of the explanations for the neglect of the stock market in macroeconomics may be the view that because the stock market fluctuates excessively, rational managers will pay little attention to the market informulating investment plans. This view is shown to be unfounded by demonstrating that rational managers will react to stock price changes even if the stock market fluctuates excessively. Finally, we review the extremely important issue of whether the market does fluctuate excessively, and conclude that while not ruled out on a priori theoretical grounds, the empirical evidence for such excess fluctuations has not been decisive.

download in pdf format
   (1252 K)

email paper

This paper is available as PDF (1252 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w1291

Published: Fischer, Stanley and Robert C. Merton. "Macroeconomics and Finance: The Role of the Stock Market." Carnegie-Rochester Conference Series on Public Policy, Vol. 21, (1984), pp. 57-108. citation courtesy of

Users who downloaded this paper also downloaded these:
Schwert w2798 Why Does Stock Market Volatility Change Over Time?
Christiano and Fisher w10031 Stock Market and Investment Goods Prices: Implications for Macroeconomics
Blanchard, Rhee, and Summers w3370 The Stock Market, Profit and Investment
Diebold and Yilmaz w14269 Macroeconomic Volatility and Stock Market Volatility, Worldwide
Grossman and Shiller w0564 The Determinants of the Variability of Stock Market Prices
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us