Analyzing the Effect of Change in Money Supply on Stock Prices Biniv Maskay

Billions of dollars worth of shares are traded in the stock market on a daily basis. Many people depend on the stock market as their primary source of income while others have their retirement funds tied to the stock market. The importance of “good” performance of the stock market is obvious. History has shown that a downturn in stock prices can cause major disturbances in the lives of many. Also, the strength of a stock market can have a major effect on the economy through its influence on real activities such as consumption, investments etc. Monetary policy is one of the most effective tools that a central bank has at its disposal. In fact, many economists consider monetary policy to be the most important macroeconomic policy. The central bank uses monetary policy frequently to cause a desired level of change in real activities. These frequent changes in monetary policy are believed to have a significant effect on the stock market. It is important to analyze the relationship between the most effective economic policy, namely monetary policy, and one important determinant of the economy, the stock market. In this study, I will analyze this delicate yet crucial relationship between monetary policy and the stock market. Specifically, I will look at the relationship between the money supply and stock market prices. Money supply is one of the components of monetary policy that the Federal Reserve uses. Changes in money supply can be either anticipated or unanticipated by the people. It is believed Biniv Maskay is a senior economics major and business administration minor from Kathmandu, Nepal. He wrote “Analyzing the Effect of Change in Money Supply on the Stock Prices” for his senior project class. that anticipated and unanticipated changes in the money supply affect the stock market differently. Taking this point into consideration, I will differentiate the anticipated and unanticipated components of changes in the money supply and analyze how each affects stock market prices. In Section II, the theoretical framework is discussed along with the relevant literature on the topic. Next, in Section III, the variables and data set utilized in this study are described and the empirical model is developed. Results are presented and discussed in Section IV. The paper concludes with Section V, in which suggestions for further studies are pointed out and policy implications are considered.