Stock Market Crash Causes Depression

October 29, 1929.  Panic in the stock market by itself has little effect on the overall economy.  The potential effect on physical investment in plant and equipment is, however, enormous.

The importance of the psychological effects of the stock market crash were noted by Keynes:

 
"...most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits--of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities...if the animal spirits are dimmed and the spontaneous optimism falters... enterprise will fade and die," - J.M Keynes: The General Theory of Employment, Interest, and Money, 1936.

 

The following graph of net capital formation (investment spending less depreciation) shows vividly the evidence for a link between the stock market and physical investment.

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