Thursday, 4 July 2013

Money and the Stock Market: What is the Relation?

By Frank Shostak (August 2006)

Is it true that changes in stock prices are predominantly set by changes in money supply? At some level, it makes sense that an increase in the rate of growth of money supply strengthens the rate of increase in stock prices. Conversely, a fall in the rate of growth of money supply should slow down the growth momentum of stock prices.

The chart below seems to indicate that the yearly rate of growth of the combined South East Asian stock prices has a good visual correlation with the yearly rate of growth of the combined money M1.

Austrians have generally accepted this causal connection, though for different reasons than others, as I will explain below.

But first we must deal with the contrary view. Some economists who follow the footsteps of the post-Keynesian school of economics have questioned the importance of money in driving stock prices.

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