Money and stock prices.

Abstract

This study was conducted to examine the issues and controversy surrounding the relationship between the money supply and stock prices. The specific issue addressed in this study was whether current stock price changes were significantly related to past or future changes in the money supply.

The investigation began with an examination of the theoretical framework for such a relationship. This was followed by a review of the related empirical studies. Finally, additional empirical evidence was presented.

The examination of the theoretical framework included the stock valuation model, the quantity theory of money, the rational expectations hypothesis, and the efficient market hypothesis.

The empirical portion of this study employed multiple regression analysis and correlation analysis to examine the relationship between current stock price changes and past and future changes in the money supply for the period 1960-82 and the subperiods 1960-72 and 1978-82. The money supply measures were M1 and M2, revised and seasonally adjusted. The stock price measure was the Standard and Poor's Composite 500-Stock Index. Percentage changes in both series were examined for both monthly and quarterly data. Additionally, a Chow test was conducted to test for structural differences in the relationship between the periods 1960-72 and 1973-82.

The results of the empirical portion of the study indicate that the nature of the relationship can best be described as one where current changes in stock prices are related to past money supply changes. However, future changes in the money supply, at least a measured by monthly M2, also appear to be significantly related to current stock prices when the 1973-82 and 1960-82 periods are examined. The findings also indicate that there appears to be a structural difference in the relationship between the money supply and stock prices between the periods 1960-72 and 1973-82.

Moreover, the findings indicate that several factors, such as differences in the periods examined, differences in measures of money supply, differences in data bases employed, differences in methodologies, etc. may account for differences in the findings and conclusions of previous studies.