Stock market participation in the U.S. has changed dramatically over the past four decades. In the mid-1980s, fewer than 30 percent of households held equity. By the early 2000s, more than half of U.S. households owned equity, either directly or through mutual funds, 401(k)s, and IRAs. As participation widened, the way stock market fluctuations passed through to household spending may have changed, with potential implications for how the broader economy behaves. An argument can be made that the rise in equity market participation has dampened the response of output to interest rate changes as stock market fluctuations are now spread across a larger share of households, moderating movements in consumer spending, asset prices, and investment spending.
Why Does Participation Matter?
Before turning to the data, it helps to set out the mechanisms at work. I develop a model in which households differ in their access to financial markets: participants trade both bonds and equity, while nonparticipants hold only bonds. Participants finance their equity positions with debt, giving them leveraged exposure to a procyclical asset. As a result, they bear more aggregate risk than nonparticipants, and their consumption is more responsive to interest rate changes. When rates rise, equity prices fall and participants’ financing costs increase. Both forces push participants to cut consumption by more than nonparticipants.
As participation rises, the same changes in aggregate equity market value are spread across a larger pool of households. Each participant holds a smaller per-capita equity position and takes on less leverage. Consequently, the wealth effect of a given stock-price movement and the financing pressures created by higher interest rates are both weaker. Participants’ consumption becomes less responsive to interest rate changes, and their valuation of future firm profits also becomes less sensitive, reflecting both smoother consumption and milder financing conditions. The response of stock prices is therefore more muted.
It may seem counterintuitive that adding more households from the group that is more responsive to interest rate changes can produce a smaller aggregate consumption response. Two opposing effects are at work. A larger share of participants, by itself, would make aggregate consumption more responsive. But as participation rises, each participant responds by less. In the model, this reduction in individual responsiveness more than offsets the effect of having more participants.
This matters for the real economy because stock prices help determine firms’ incentives to invest. When stock prices fall, the market value of installed capital declines relative to the cost of building new capital, making investment projects less attractive. Smaller movements in stock prices therefore translate into smaller adjustments in investment spending. The more muted investment response also dampens movements in output and labor income, further reducing households’ consumption responses.
The model is calibrated to match the empirical responses of equity prices and investment spending to unexpected interest rate changes, as well as business-cycle and asset-pricing moments. Under the parameterization, comparing a low-participation economy, at 25 percent, with a high-participation one, at 55 percent, the output response to an unexpected interest rate increase is 20 percent smaller.
Stockholders and Nonstockholders Respond Differently
With this mechanism in mind, one can examine whether the household-level patterns predicted by the model appear in the data. Using household-level nondurable consumption data from the U.S. Bureau of Labor Statistics’s Consumer Expenditure Survey for the period 1990–2007, I estimate how the differential consumption response between participants and nonparticipants evolved over time following unanticipated interest rate increases.
Two patterns stand out. First, participants cut consumption by more than nonparticipants following an unexpected increase in interest rates. Second, this gap has narrowed considerably as participation has risen. The chart below shows the differential response between the two groups, estimated over rolling fifteen-year windows: it is large and negative in the mid-1990s but moves toward zero by the mid-2000s, in line with the rise in participation documented in the Federal Reserve Board’s Survey of Consumer Finances.
Participants’ Extra Consumption Response Has Narrowed Over Time
Differential log consumption response (P vs. NP, ppt)
Notes: The chart shows the differential consumption response between stock market participants (P) and nonparticipants (NP), estimated over rolling fifteen-year windows. The response is measured as the average difference between one and three years after an unanticipated interest rate increase. Negative values indicate that participants cut consumption more than nonparticipants.
The Aggregate Output Response Has Weakened
The model predicts that broader equity market participation dampens the response of aggregate output to interest rate changes. To assess this prediction, I examine how the response of industrial production evolved as participation rose.
Using twenty-year rolling-window local projections of monthly industrial production onto unanticipated interest rate changes, it is evident that the response of output has weakened alongside the secular rise in participation (see chart below). This pattern holds for both the peak response and the average response over the two-to-three-year horizon following a shock.
Output Responses to Interest Rate Changes Weakened as Participation Rose
Response of log IP
Participation rate (ppt)
Notes: The chart plots the peak (blue) and average (red) responses of log industrial production (IP) to an unanticipated interest rate increase, estimated using twenty-year rolling windows at monthly frequency. The responses are measured over horizons of 2 to 2.5 years after the shock. The gold line, plotted on the right axis, shows the equity market participation rate.
Additional evidence comes from analysis that shows states with lower equity market participation exhibit larger consumption responses to interest rate changes, even after accounting for differences in demographics, income, and industry composition.
Conclusion
Taken together, these results suggest that changes in household portfolio composition can alter how strongly the economy responds to interest rate changes over time. When relatively few households own equity, stock market risk is concentrated among a smaller group of investors, amplifying movements in spending, asset prices, and investment following shocks. As participation broadens, that risk is spread across a larger share of the population, reducing the average exposure across participants to any given change in equity market capitalization and easing the financing pressures associated with interest rate changes. Household spending and asset valuations therefore become less responsive, leading firms to make smaller adjustments in investment spending.
The rise in participation coincided with other structural changes in the economy, so these findings should be interpreted with caution. Nevertheless, the evidence from household consumption, aggregate output, and cross-state comparisons (conducted using this model, but not discussed here) points in the same direction and is consistent with the mechanism described above. Shifts in household portfolio composition therefore appear to be a meaningful determinant of how interest rate changes pass through to the real economy.
Juan M. Morelli is a research economist in the Federal Reserve Bank of New York’s Research and Statistics Group.
How to cite this post:
Juan M. Morelli, “Has Broader Stock Market Participation Changed How Interest Rates Affect the Economy?,” Federal Reserve Bank of New York Liberty Street Economics, August 19, 2026, https://doi.org/10.59576/lse.20260819
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Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).
