How do stock markets affect the real economy, and does their impact differ depending on the level of economic development? These questions are particularly important as countries seek to develop deeper and more efficient equity markets, yet the economic benefits of such development may vary substantially across economies.
This paper contributes to addressing these questions by developing a macroeconomic model that integrates four main channels through which equity markets influence the economy:
- equity wealth effects on household spending;
- valuation-driven investment incentives;
- the impact of financing conditions on firms’ investment and balance sheets;
- and productivity gains from equity market development.
The model is calibrated to reflect the different financial structures of advanced economies (AEs) and emerging and developing economies (EMDEs), and successfully reproduces several key features observed in the data, including the strong leading relationship between equity valuations and real economic activity.