Testing the Neutrality of Money towards Real Output: A Case of Malaysia

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.