Monetary Expansion and Stock Returns in Pakistan (Fiscal AND MONETARY Issues) (Report‪)‬

The effect of changes in money supply on stock returns has been a matter of controversy among economists for many decades. One school of thought says that any change in money supply creates a wealth effect which changes the price level of various assets. The other school of thought argues that if stock market is efficient, it would already have incorporated all the current and anticipated changes in. money supply and therefore a causal relationship between changes in money supply and stock prices will not be established. This study attempts to examine the causal relationship between money supply and stock prices in Pakistan economy using monthly data from June 1991 to June 1999 and applying Co-integration and Error Correction Models. The Co-integration analysis suggests that, in general, there exist a long run relationship between money supply and' stock prices. The Error Correction Model verifies long run relationship between stock prices and M2 and suggests a unidirectional causality running from M2 to stock prices. The model also shows the evidence of short run effects of M2 on stock prices. The analysis suggests that the stock market is not efficient with respect to money supply.