Monetary Expansion and Stock Returns in Pakistan
The effect of changes in money supply on stock returns has been a matter of controversy among economists for many decades. Those in favour of presence of links between money market and stock market argue that any change in money supply creates a wealth effect which disturbs the existing equilibrium in the portfolio of investors. When they re-adjust their asset portfolio, a new equilibrium is established in which the price level of various assets is changed. On the other hand, if the stock market is efficient, it would already have incorporated all the current and anticipated changes in money supply. Consequently, a causal relationship between changes in money supply and stock prices will not be established. Moreover if the change in money supply coincides with a corresponding change in the velocity of money, it will not have any effect on stock prices. The pioneering work in this regard was done by Sprinkel (1964). Using the data from 1918 to 1960, he found a strong relationship between stock prices and money supply in the United States. His conclusions, however, were mostly based upon graphical analysis. Sprinkel’s study brought many conceptual and methodological issues in the forefront. Elaborate statistical techniques were used to explore the relationship between money supply and stock prices. For example, Rozeff (1974) conducted an extensive study and concluded that U.S. stock market is efficient with respect to monetary policy. Similarly Kraft and Kraft (1977) found no causal relationship between money supply and stock returns in the States. Ho (1983) examined the causal relationship between money supply and stock returns for six Asian-Pacific countries.1 Using monthly data and employing minimum Final Prediction Errors, he found a uni-directional causality from money supply to stock prices for Japan and Philippines but bi-directional causality for Singapore.
Volume (Year): 38 (1999)
Issue (Month): 4 ()
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- Kraft, John & Kraft, Arthur, 1977. "Determinants of Common Stock Prices: A Time Series Analysis," Journal of Finance, American Finance Association, vol. 32(2), pages 417-25, May.
- Ho, Yan-ki, 1983. "Money supply and equity prices : An empirical note on Far Eastern countries," Economics Letters, Elsevier, vol. 11(1-2), pages 161-165.
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