From the monthly archives:

August 2014

Financial market observers, investment bankers chief among them, have long theorized about the relationship between the growth in the money supply and the performance of equity markets. Here’s an empirical update on the discussion.

Money Supply Growth

The first chart below shows the growth in money supply by country since 2007, as measured by M2.  As a brief reminder or introduction, M2 is the sum of total currency in circulation and in bank vaults, bank reserves, traveler’s checks, demand deposits, checkable deposits, savings deposits, and time deposits.  All numbers are in local currency; some countries were excluded due to lacking data.

On top in the money supply expansion game is Venezeula, with an overall growth of 867%.  The next largest expander has been Azerbaijan at 755%, followed by Ghana at 583%, Mongolia at 558%, Bolivia at 455%, Iraq at 377%, and Argentina at 354%.

On the bottom, the most prudent of central banks includes Portugal, with a growth in assets since 2007 of just 2.2%.  Portugal is followed by Ireland at 2.9%, Greece at 4.1%, Luxembourg at 13.7%, and El Salvador at 16.8%.

money suply

Growth in Equity Market Values

With the growth in money supply as the first side of the coin, the other side is the growth in equity prices.  Here’s the look at the performance of equity markets, by country, over the same period, 2007 – 2014.

On top in the equity market appreciation game since 2007 is the national exchange of Iran, with total appreciation of 670%.  The other four of the top five performing national equity markets include Argentina at 237%, Indonesia at 177%, Philippines at 121%, and Thailand at 116%.

On the other end, the top 5 poorest performing equity markets since 2007 include Botswana at -98%, Cyprus at -74%, Greece at -58%, Kazakhstan at 58%, and Macedonia at -56%.


Putting the Two Together

With the two components addressed, here’s the connection between the expansion in money supply and the performance of equity markets.

The scatterplot graphic shows the correlation between the two, with each dot representing a country month.  The plot is from 2007 to year-to-date 2014. The positive and statistically significant regression line indicates that as a given country’s money supply increases, so does the given country’s equity markets.

As a caveat, all numbers are in local currency values.  Increases in a country’s money supply certainly affects other variables, including inflation and exchange rates.  A more complete analysis may want to include these factors.  With this caveat taken into account, the main conclusion still stands – money supply increase are generally correlated with equity market appreciation.

Interestingly, the correlation coefficient comes out to 0.28, meaning that a 1% increase in the money supply is correlated with a 0.28% increase in a given country’s equity market.



Overall, in inspecting the relationship between the growth in money supply and the performance of equity markets, it certainly appears as though the two are connected.  Of course, before arriving at a complete conclusion, other variables may need to be included, including country inflation and exchange rate changes.

With the caveat that correlation does not imply causation, one could presume, simply based on correlation and common sense, that when central banks start getting serious about reducing the money supply (if they ever do), equity markets would be one of the first areas where the effects would be felt.

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Market observers (investment bankers chief among them) have long debated how political Federal Reserve policy is.  Some economists think officials at the Federal Reserve are completely immune from political pressure, akin to the way some legal observers think Supreme Court justices are impartial observers.  Others, perhaps the more enlightened ones, see Federal Reserve policy as almost completely political, similar to the way many legal observers see political agendas out of the supposedly impartial opinions of Supreme Court justices.

Here’s a look at what the Federal Funds target rate has been by U.S. President.

Federal Funds by President 

Although bunched together closely, one can clearly see trends by President.

President Obama

The current president is the most obvious outlier.  Since he took office in January 2009, President Obama has yet to see the Federal Reserve increase the Federal Funds target rate.  Instead, President Obama has experienced consistent losing throughout his Administration.  For some observers, this is no surprise given that the sitting president appointed the the current chair of the Federal Reserve.

Bush II

Interestingly, the figure shows much less consistency in the Federal Funds rate for Obama’s predecessor – Bush II.  In the first year of Bush II’s presidency, the Federal Funds rate was decreased from about 6 percent to about 1.75 percent.  The Federal Funds rate then floated around bottom for the next three years.  After spending three years in the trough, Mr. Greenspan’s Federal Reserve began tightening interest rates, with the Federal Funds rate going from a low of 1 percent to about 5 percent over the course of the next two years.  The rate then spent the next year at about 5.25 percent, after which the Federal Reserve began decreasing the target rate at a fairly rapid pace to end Bush II’s presidency.

President Clinton

Bush II’s presidency was preceded by President Clinton.  Surprisingly, although the 90s was full of heavy equity price appreciation, the Federal Funds target rate was much less volatile during Clinton’s presidency than it was during Bush II’s administration.  Clinton came into office with the Federal Funds target rate at 3 percent.  The rate doubled over the next two years to 6 percent.  After reaching 6 percent, the Federal Funds target rate spent the remainder of Clinton’s presidency floating in the narrow 5 percent to 7 percent range.

Bush I

Bush I consistently saw the Federal Reserve decrease the target rate during his time in office, going from 9 percent to 3 percent over his four years.

President Reagan

During Reagan’s time in office, the Federal Reserve only increased the Federal Funds target rate for a few months at a time.  The most severe was early in Reagan’s presidency, when Mr. Volker increased the rate from about 14 percent to as high as about 30 percent (third and fourth months of Reagan’s presidency).  Besides Mr. Volker’s defeat of the Carter years’ hyperinflation, the Federal Funds rate trended downwards during most of Reagan’s time in office.

Here’s another look at the numbers with a different view.  Each row represents each of the past 11 U.S. presidents (please note the different vertical axes).

Federal Funds by President (Different Scaled Axes)

So, any politics involved in the setting of the Federal Funds target rate?  It’s impossible to tell from the graphics or discussion if there is a bias.  Here’s a simple regression result to test further.

Simple Probit Regression Check

The probit regression results given below has as the dependent variable whether the Federal Reserve was in a general tightening (=1) or loosening cycle (=0).  The predictor is whether the president at the time was a Republican (=1) or Democrat (=0).

Interestingly, the -0.026 indicates that, in general, Republican presidents generally see less Federal Reserve tightening cycles than Democratic presidents.  The results, though, are not statistically significant at the 95 percent level, nor is the model a good fit.  Interesting though.


Overall, although there may be politics behind the setting of Federal Reserve policy, in particular the Federal Funds target rate, it’s hard to show by just looking at the target rate by U.S. president.

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