The relationship between money supply and stock prices | Finance

By: Hunkar Ozyasar

Money supply and stock prices are closely correlated.

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Money supply is one of the most basic parameters of an economy and measures the abundance or scarcity of money. Stock prices tend to increase when the money supply in an economy is high. The abundance of money circulating in the economy both makes more money available to invest in stocks and makes alternative investment instruments, such as bonds, less attractive.

Money income

The amount of money in an economy is called the money supply. This includes much more than banknotes and coins in circulation. In fact, physical money is less than a tenth of all money in a typical developed economy. The rest of the money in the economy is virtual. Unused line of credit in your credit card account or in a large business’s commercial bank account is considered money supply because it can be used as easily as bills and coins to purchase money. goods and services. Economists keep a close watch on the money supply, as this figure determines purchasing power and therefore potential demand for products and services.

The Fed and interest rates

The US Federal Reserve, often referred to as the Fed, can control the money supply through a number of measures. The main method the Fed uses is to buy and sell treasury bills. The result is either a withdrawal or an injection of money into the economy. The immediate result is a change in interest rates. When there is a lot of money around, it becomes cheaper to borrow it. When the money supply is low, few individuals and institutions will have funds to lend. Borrowers must therefore offer higher interest rates in order to be able to borrow. Interest rates are often referred to as the cost of money.

Interest rates and stocks

An increase in the money supply and the resulting fall in interest rates make stocks a more attractive investment. When investors can only get a low level of return by lending money, whether to a bank or a business or by buying treasury bills, they tend to transfer more money to stocks. . This is often referred to as the pursuit of performance. Imagine an investor who calculates that he needs $ 500,000 to retire comfortably in 10 years, but only has $ 400,000 in his retirement account. If bank deposits offer an annual interest rate of 5%, simply keeping the money in the local bank will result in a balance greater than $ 500,000 in 10 years. But if bank deposits earn 2% or less, the investor will look for riskier, but potentially more profitable alternatives, such as stocks.

Growing demand

Another reason that stocks do well when the money supply is high is the increase in general demand in the economy. When loan rates are low, mortgage rates also fall, making housing more affordable and increasing demand for items like televisions, washing machines, etc. Car sales also increase when finance rates fall. The lower rates are partly reflected in the interest rates charged on credit card purchases, and consumers are buying more of virtually every goods and services imaginable. The result is increased sales for most companies, which increases profits and generally leads to higher stock prices.

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