Money Supply and Equity Price Movements in Pakistan

Abstract

The relationship between stock prices and money supply in Pakistan is examined by monthly data from January 1992 to June 2009. The Co-integration, Error-Correction Model and Granger Causality Techniques are used to test the causal association among money supply and stock prices. The empirical results indicate the uni-directional causal relationship between stock prices and money supply. The results also indicate that stock price has negative significant short run causal effect on money supply in Pakistan. It suggests that as stock prices increase, equities become more attractive as compared to other assets; thus there is a shift from money to stock. Money supply does not determine the stock price in long run. However, during the short run, broad money M₂ has significant causal effect on stock prices. Thus stock market, in the long run, is inefficient with respect to money supply. Moreover, income and interest rate do affect the stock prices, which suggest that tight monetary policy may be used more effectively to check the movement in stock prices in Pakistan.

Key Words: Money supply, stock price, interest rate