Efficient Capital Markets and the Quantity Theory of Money.
Examines the relationship between stock returns and the money supply to clarify the apparent contradiction between Sprinkel's 1964 quantity theory, in which money supply changes are reflected in stock prices and more recent developments in the business finance literature suggesting that capital markets are efficient--meaning that current asset prices incorporate all available information. This paper combines the two theories by relating money supply to stock returns rather than stock prices and showing that predictions of money supply changes are part of the information reflected in the market. Money supply changes can be successfully forecast 1 to 3 months ahead. Cross spectral analysis shows that changes in stock returns lead changes in money supply--or money supply changes lag changes in returns--by 2 to 3 months. The combined theory fits the data better than the simple quantity theory. It does not, however, preclude the endogenous money theory that changes in the money supply respond to changes in stock prices and interest rate. 63 pp. Bibliog. (MW)