Monetary Policy, Income Growth and Price Stability in Malaysia

Malaysia is a rapidly progressing high middle-income economy. As a highly open economy with an increasingly liberalized financial sector, the implementation of a comprehensive macroeconomic policy is a challenging task. This article inquires into the efficacy of money in raising income and stabilizing price level, and it also attempts to identify the effective component of money in this direction over the period 1971-2012. The autoregressive distributed lag (ARDL) approach to co-integration confirms the existence of a long-run relationship among money, income and price level. Error correction mechanism (ECM–ARDL) models with a battery of econometric techniques such as vector autoregression (VAR) model, the Wald test and innovation accounting confirm that only M1 money supply causes a raise in income. Price level, on the other hand, negatively contributes to income. Three components of money supply namely M1, M2 and M3 lead to a raise in price or inflation where M2 money is found to be the most potent component provoking inflation. The role of income is insignificant. Competent management of monetary instruments, therefore, may promote higher income maintaining stability in price level