Stock prices, money supply, and interest rates: the question of causality

The question of causality between money supply and stock prices has been hotly debated.  Some researchers hypothesize that changes in the money supply cause changes in the economy that require investors to alter their holdings of stocks.  However, other researchers hypothesize that anticipated changes in stock prices are a front-runner to changes in the economy; and an improving stock market may mean the economy is improving and will result in an increase in the money supply to full-fill loan demand.

The authors study the period January 1980 - July 1986 using weekly S&P 500 and M1 data.  Their findings from their Granger-Sims tests show that causality runs from money supply to stock prices, then stock prices to money supply.  Through their regressions, they find that trying to predict stock prices using past money supply changes only is not very useful.

Hashemzadeh, N., & Taylor, P. (1988). Stock prices, money supply, and interest rates: the question of causality. Applied Economics, 20(12), 1603.