Money Supply and Common Stock Prices

Abstract

Beginning in the 1930s there developed a widespread misconception-in sharp contrast with the previous beliefs of classical economists -that money didn't matter. The Keynesians ruled the world of economic thought until a hardy band of economists at the University of Chicago, led principally by Milton Friedman, uncovered evidence suggesting that: One. the great depression of 1929-33 was caused, not by some inherent defect of capitalism, but by misguided actions of the Federal Reserve Board that caused the supply of money to contract by a third.' Two, 30 years of Keynesian promise had not been fulfilled; the economy danced to the tune of the supply of money, not to the discordant rhythm of a mysterious fiscal multiplier. These contributions have fueled a tremendous rekindling of interest in money. The rekindling has been accompanied by growing interest in the effect of monetary policy on the level of the stock market. Beryl Sprinkel, Michael Keran and James Meigs have all argued for the existence of a long-term relationship between money and stock prices.2'3'4 My own interest, inspired by the writings of Milton Friedman, became serious when, in 1966, I started to plot weekly changes in the money supply. The short-term correlations between changes in the money supply and changes in the level of stock prices, which are the subject of this article, first became apparent to me in 1967. In view of their short-term nature, I believe these correlations represent a new discovery in the continuing investigation into the relationship between money and s.tock prices With one exception (noted below), the money supply (M) used in the charts below consists of time and demand deposits of all commercial banks in the country plus currency in the hands of the