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

Abstract

On the theoretical ground, Keynesian believes pricing mechanism work better than government intervention, which comprised the Keynesian's 'invincible hand' in the market. Price equilibrium restores automatically, therefore, floating exchange rate regime, in which exchange rate is determined by the market force of demand and supply, is viewed as the optimum exchange rate regime to be implemented. Furthermore, floating exchange rate regime comes with high stability of real exchange rates. However McKinnon, et al. [12] claimed that, fluctuation from nominal exchange rate would be transferred to the domestic price directly and real exchange rate is maintained at fixed rate. Therefore, policy makers should implement strict monetary policy and fixed exchange rate regime to control the prices under the Keynesian's theory McKinnon, et al. [12] However, non-neutralists who violate the classical view of Keynesian's assumption, argued that, market should be non-homogeneous, where, information is imperfect, agents are behave in the different way and the changes of relative prices has to be taken into account when money fluctuation takes its place. Non-neutralists also put doubt on the price mechanism which acts as the 'invincible hand' in the market. Therefore, suggested by nonneutralists, intervention is necessary to adjust the real macroeconomic variables, specifically the discretionary adjustment. Then, exchange rate policy can be treated as the nominal anchor to achieve macroeconomic objectives. With the above mentioned reasons, non-neutralists advocate the fixed but adjustable exchange rate regime is more suitable to compliment the monetary policy. Mishkin, et al. [13] emphasized that, the McKinnon (1988)'s fixed exchange rate regime under the Keynesian's theory is different from fixed exchange rate regime proposed by the non-neutralists. The former one is considered as the hard pegged, however, the later is classified as the intermediate regime where the fixed rate is adjustable from time to time. Based on the Rational Expectation of Theory, unanticipated money supply would alter the real macroeconomic variable in short run. Thus, it forms the middle ground theorists between Keynesians and monetarists. Theorists Williamson, Krugman [14,15] who argued money is neutral in long run only, has agreed with the stance of Keynesian's theory in long run but hold the Rational Expectation theory for the short run. This group of theorists, generally, agree with the classical economic theory towards the money. In short run, due to the price rigidness, market failure and time lagged of responses, thus, money does affect real economic permanently. Furthermore, Mollo,

Testing the long-run neutrality and superneutrality of money in a developing country: Evidence from Iran

“…The results indicated that monetary growth has had a positive impact on inflation in Vietnam, and that inflation has been increasing for three months in response to a positive shock to monetary growth and had no impact on production, budget deficit growth, and interest rate. Sam and Geetha [41] examined the long-run behavior of monetary aggregates towards the Malaysian economy based on quarterly data ranging from 1996 to 2014. In this paper, the unanticipated money supply was tested under the vector error correction model (VECM).…”