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

Mohamed Ariff*, Tin Fah Chung, Shamsher M.

*Corresponding author for this work

Research output: Contribution to journalArticleResearchpeer-review

9 Citations (Scopus)

Abstract

The money supply impacts on interest rate and liquidity were first proposed in 1961 by Friedman, the late Nobel laureate. The liquidity effect has yet received unanimous empirical support. Also, research interest on liquidity subsided in the 2000s. Using quarterly data over 1960-2011 and simultaneous solution to a system of equations, this paper reports positive liquidity effect from money supply. By extending the system of equations with a liquidity equation and after controlling the effect of earnings, evidence is found of a significant positive effect from liquidity on share prices. Money supply is found to be endogenous as in post Keynesian theory. These findings, obtained after solutions to several econometric deficiencies in prior studies, provide clear verification of the endogenous money supply theory, money effect on liquidity and on the extension of the model for a liquidity effect on asset prices.

Original languageEnglish
Pages (from-to)202-220
Number of pages19
JournalGlobal Finance Journal
Volume23
Issue number3
DOIs
Publication statusPublished - 2012

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