A test of the linkage among money supply, liquidity and share prices in Asia
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Friedman’s proposition that money supply increases should lead to liquidity surges – to credit expansion – has yet received unanimous empirical support. We extend a test for this liquidity effect on non-bank share prices in four major Asian economies, which have not been studied. Using lengthy quarterly data series over 1966–2012, our results from applying single, and cointegration equations using dynamic OLS method, suggest money supply changes lead to a positive liquidity effect, as per the theory prediction. We also show that liquidity changes have a significant positive effect on share prices, after controlling the effects of earning changes, regime changes and the global financial crisis. These findings, obtained after solutions to serious econometric issues in existing studies, appear to provide a clear verification of theory on the money supply effect on liquidity and liquidity effect on non-bank share prices.
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