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Do stock prices have any effect on the money supply of an economy? Please provide a simple example if possible.

Intuition suggests there is more money around when prices are high (consider for instance the dotcom boom). I guess the answer may be dependent on what definition of money supply one uses (M0-M4).

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They may, but probably not much. Because stocks cannot be used as a substitute for money in most transactions there is no direct channel. However, because stocks can act as collateral for loans, and loans have the capacity to create money through the money multiplier mechanism they can have some effect, just as anything that relaxes borrowing constraints could increase the money supply.

Collateralized loans make up the vast majority of bank debt. Suppose, for example, that banks only made collateralized loans. Then when stock prices go up, some borrowers formerly at the limits of borrowing constraints due to limited collateral, would be able to take out additional loans. These loan proceeds could then be deposited in banks or spent, either way likely ending up in banks eventually where, through the mechanism of fractional reserve banking, they could be used to create additional money. However, as you can see in the figures below, margin debt is a very low fraction of GDP in contrast to say household overall debt. So in general this is not going to be a big channel.

enter image description here Source: Ominous Sign as Margin Debt Continues to Rise

enter image description here Source: Wikipedia Subprime mortgage crisis page

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    $\begingroup$ I would add that to the extent that the underlying value of stocks are wealth-related, higher values of stocks might lead to more aggressive purchasing, which in turn increases the velocity of money. There is a similar literature on the wealth effects of housing. $\endgroup$ – RegressForward Jun 11 '15 at 17:37
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The short answer to your question is no, stock prices have no direct effect on the total amount of money in an economy, just as the price of apples has no effect on the total amount of money in an economy. The wikipedia page on money has an explanation of the various ways you might define money, and none of them include the valuation of stocks. Here's the requested simple example: Say there are \$100 in circulation. There is one stock traded, and it is valued at \$10. Then, it is valued at \$20. But there is still \$100 in circulation.

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  • $\begingroup$ So if the stock appreciated to $110, there would not be enough money in the economy to buy it? $\endgroup$ – Gruber Jun 12 '15 at 13:21
  • $\begingroup$ Yes, and that is the current situation in the US, the total valuation of assets far outweighs the amount of money in the economy. $\endgroup$ – NickJ Jun 13 '15 at 22:52

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