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

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Abstract
The purpose of this study is to examine the statistical relationship between the supply of money and stock price levels and between the level of interest rates and stock prices. The current literature in financial economics offers differing opininon on each of these relationship. This research addresses a significant aspect of this debate by examining the direction of causality between the money supply, stock prices and interest rates. Using Granger–Sims' test for determining unidirectional causality, we find that the relationship between the money supply and stock prices is characterized by a feedback system, with money supply causing some of the observed variations in the stock price levels and vice versa. With respect to the relationship between stock prices and interest rates, the results are not as conclusive. In this instance, the causality seems to be mostly running from interest rates to stock prices, and not the other way around.