The Money Supply and Stock Prices: The Case of Malaysia

The relationship between stock prices and macroeconomic variables has been the subject of interest for many years. Generally, movement in the stock prices is hypothesized to be affected by changes in economic fundamentals. In this paper, we investigate the relationship between changes in money supply and stock prices in the Kuala Lumpur Stock Exchange. We employ the Vector Autoregression (VAR) methodology in identifying the relationship between the two. A vector of five variables namely money, interest rates, output, consumer prices and stock prices as postulated by the standard share valuation model is incorporated in the VAR system. The Granger causality test, variance decomposition analysis (VDA), and impulse response functions (IRF) analyses are used to trace the impact of shock in moncy supply on stock prices. The result of the causality test show significant uni-directional causation running from money supply to stock prices. VDA also supports the importance of money supply in determining stock prices. The IRF indicates stock prices responsed positively following monetary expansion and the impact peaks after seven months from the initial shock but declines gradually thereafter. To the extent that stock prices reflect real economic performance, these findings are consistent with the long-run effect of money on the real sectors.