Unanticipated monetary growth and Malaysian stock returns: a test of L-S-W policy ineffectiveness proposition

Abstract

The L-S-W (Lucas (1972, / 973) and Sargent and Wallace (1975)) policy ineffectiveness proposition of the rational expectation model is tested in this study. The proposition (claims that unanticipared changes in monetary aggregates exert significant influence on real economic activities while anticipated policy is neutral. In line with this, the efficient market hypothesis indicates that in an efficient market share prices incorporate anticipated information instantaneously leaving only the unanticipated components of the information set to affect share prices. We investigate this proposition of the rational expectation model and its implication on market efficiency on the Malaysian stock returns. Specifically the response of share returns toward changes in actual and decomposed (anticipated and unanticipated) growth of monetary aggregate is analyzed. The single equation regressions and the system estimation of vector autoregressions (VAR) both point toward the validity of L-S-W proposition. The stock returns react signnificantly to actual money growth in a positive fashion. Result o( decomposed money growth series indicate that these significant reactions are largely due to the unanticipated component of monetary growth. Movement of share prices is neutral with respect co the anticipated monetary growth. These.findings generally favour the L-S- W policy ineffecuveness proposition. Thus, Malaysian share market portrays an efficient pricing process and ;judging the impact of monetary, policy requires special attention to the unanticipated component.