Money supply, interest rate, liquidity and share prices: A test of their linkage

Mohamed Ariff, and Chung, Tin-Fah * and Shamsher M., (2012) Money supply, interest rate, liquidity and share prices: A test of their linkage. Global Finance Journal, 23 (3). pp. 202-220. ISSN 1044-0283 (Submitted)

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Abstract

This paper reports new evidence of a liquidity effect on share prices from money supply changes. Money supply impacts on interest rate and liquidity were first proposed in 1969 and there is evidence that money supply increase leads to interest rate decline. Yet the proposition that money supply increase should lead to liquidity surge – thus to credit expansion – has yet received unanimous empirical support. Using quarterly data over 1968-2011, our results from a two-stage simultaneous solution of a system of equations indicate that money supply changes lead to a positive liquidity effect, as per the theory prediction. By extending the liquidity equation to asset prices, we also show that liquidity change has a significant positive effect on share prices, after controlling the effect of earnings. These findings, obtained after solutions to serious econometric issues of existing studies, appear to provide a clear verification of theory on the money supply effect on liquidity and on asset price.

Item Type: Article
Additional Information: First author is with Bond University; 2nd author is with the Australian University Programme, Sunway College and a PhD student with Universiti Putra Malaysia; 3rd author is with INCEIF University, Kuala Lumpur.
Uncontrolled Keywords: Liquidity; Money supply; System of equations; Causality test; Share prices; Interest rate; Two-stage least squares; Structural break
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HJ Public Finance
Divisions: Sunway College > Australian University Program
Depositing User: Ms. Molly Chuah
Date Deposited: 09 Jul 2013 01:37
Last Modified: 09 Jul 2013 01:37
URI: http://eprints.sunway.edu.my/id/eprint/159

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