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Money Supply Macroeconomics

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.3.1 Money Supply Money supply is one of the macroeconomic variable that might effect to stock market returns. Changes in money supply are determined by the result of the interaction between the public, financial institutions and central banks. Besides, money supply can be classified into various categories which include M1, M2, and M3. This is according to the type and the size of account in which the instrument is kept (Schwartz, 2008). In this study the broad money M2 is used for analysis of the money supply in the economy since it consist of M1, saving and time deposits in addition with non-institution money market mutual funds.

However, Friedman and Schwartz (1963) examined the link between money supply and stock market returns. Their …show more content…

It emphasizes that exchange rate are determined by the fluctuation in the stock market and work under the demand and supply framework. Stock market return upward will attract the foreign investors to invest in the stock and diversify their portfolio, therefore it brings more foreign currency to the country and increase the demand for local currency, which cause local currency appreciation. While decline in stock market return, the stocks lose its attraction to be added in the portfolio and hence investors will sell out their stocks to avoid further losses. This leads to lower demand for local currency and depreciation of the local currency (Zarrar & Rahman, …show more content…

They stated that depreciation may lead to cost of imports increase, domestic price level increases, therefore it would expectedly have a negative impact on stock market returns. Similarly, Adjasi & Biekpe (2005) stated that exchange rate depreciation will reduce stock market return. Morley & Pentecost (2000) affirm that stock markets and exchange rates are related, and it is through a common cyclical pattern rather than a common trend. When foreign investors purchase a country’s stock, the capital inflow will results in domestic currency appreciation, while currency depreciation when capital outflow. However, there is a significant long run relationship exists between exchange rate and stock market returns (Muktadir-al-Mukit,

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