Abstract
Neutrality of money has a long debate towards real output. Rational expectation theory states, money is neutral at all time, however, short run effect is mainly caused by the unanticipated money supply. On the opposite stance, based on the theory of rational belief, money is neutral neither in short run nor long run. This paper has examined the long run behaviour of monetary aggregates towards Malaysia economic through quarterly data ranging from 1996 to 2014. Unanticipated money supply which is obtained based on Barro model; M1, M2 and M3 have been tested under the Vector Error Correction Model. Time dummy has been included to accommodate the period of financial crises and fixed exchange rate regime era. However, there is little evidence to support the view of neutrality of money hold in Malaysia. The findings provide evidence to support the decision of Malaysia authority getting out from rigid exchange rate policy since 2005.
Highlights
Keynesians believe money is neutral in both short run and long run; any increment of money supply does not alter the real macroeconomic variables such as, real output or real unemployment level
Lucas [10] and Sargent & Wallace [11] developed the Rational Expectation Hypothesis to enhance the explanation of short run changes between money supply and real macroeconomic variable
Rational Expectation Hypothesis brought in the concept of unanticipated money supply that gave unexpected changes towards the real macroeconomic variables in short run
Summary
Keynesians believe money is neutral in both short run and long run; any increment of money supply does not alter the real macroeconomic variables such as, real output or real unemployment level. This is because the inverse relationship between inflation rate and unemployment observed by Phillip Curve This approach is insufficient to explain the Phillip Curve in long run, when, market agents receive full enough information to act according to the changes of money aggregation. Rational Expectation Hypothesis brought in the concept of unanticipated money supply that gave unexpected changes towards the real macroeconomic variables in short run. This explains authorities tend to keep the details of implemented policies away from public in order to avoid unexpected result, such as, keeping the basket weight confidentially while implementing basket pegged exchange rate regime. This group of scholars claimed that, policy makers should employ discretionary policy to achieve macroeconomic objective, in term of mazimizationf of employment and economic growth sustainability
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