Stock buybacks have a mildly positive effect on the economy as they lead to rising stock prices. Research has shown that increases in the stock market have an ameliorative effect on consumer confidence, consumption and major purchases. This term has been dubbed "the wealth effect," and it has been cited by central bankers as a reason to favorably look upon rising asset prices.

This increase in confidence among people is the major mechanism through which increasing stock prices benefit the economy. When consumers are feeling confident about the future, they are more likely to spend money and make purchases like automobiles and homes, which drive a large portion of economic activity.

Rising stock prices improve the household balance sheet on the asset side. They bring people's retirement and financial goals closer and make them more attainable for others. Bull markets in stocks tend to have a greater effect on consumption for people who own the most stocks. Therefore, stock prices have a strong correlation to the luxury goods market.

It is important to note that while stock buybacks have a mild effect on the real economy, they tend to have a much more direct and positive effect on the financial economy. In many ways, the financial economy feeds into the real economy and vice versa.

One way improvements in the financial economy impact the real economy is through lower borrowing costs for corporations. In turn, corporations are more likely to expand operations or spend on research and development. These activities lead to increased hiring and incomes. For individuals, improvements in the household balance sheet enhance chances they leverage up to borrow to buy a house or start a business.

Stock buybacks happen as companies either borrow money or deploy excess cash flows to purchase their own shares on the open market. This is one way companies can return money to shareholders. This increased demand for shares leads to higher stock prices. This behavior tends to proliferate when interest rates are low and the economy is growing slowly. Notably, this increases prices by decreasing demand; it has no effect on stock valuation.

During times of rapid growing demand, companies are more inclined to invest in their own business. When companies are less confident of economic conditions, they choose the conservative route of share buybacks, which is a more certain way of pleasing shareholders. Capital expenditures are risky, and corporate finance managers would have their necks on the line if business conditions deteriorated and demand did not show up.

In the process, the number of outstanding shares decreases. This makes remaining shares more attractive as metrics such as earnings per share or dividends look more attractive. In recent decades, share buybacks have overtaken dividends as a preferred way to return cash to shareholders as there is more preferential tax treatment.

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