Friday, March 25, 2005

The Role of Finance in the Investment Bust of 2001

William Poole*President, Federal Reserve Bank of St. Louis
Annual Southwestern Finance Association MeetingAdams Mark HotelSt. LouisMarch 8, 2002

A recurring topic of debate among economists and finance experts is the role of financial markets in cycles of boom and bust in the real economy. This discussion has flared up once again in the wake of the Recession of 2001. The performance of the U.S economy in the 1990s was remarkable, and so was the performance of the stock market. Starting in spring of 2000, both the stock market and real economic activity weakened considerably. In the real economy, we observed a sharp drop-off in private business fixed investment. In the financial sector, we witnessed the stock market delivering disappointing returns for two consecutive years. The number of initial public offerings (IPOs) fell dramatically, and the market for venture capital dried up. In fact, given that the financial indicators turned ahead of real investment, there is a prima facie case that financial stringency contributed to the decline in physical investment spending. Of course, the financial environment does not come out of the blue; weakening prospects of the tech companies had a lot to do with the financial stringency they faced starting in early 2000.



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