The Impact of Interest Rates and Money Supply on KLCI

Mohamad Affendi, Mohamad Akid (2020) The Impact of Interest Rates and Money Supply on KLCI. Final Year Project (Bachelor), Tunku Abdul Rahman University College.

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Abstract

As interest rates rise, in general the price of securities will fall. At the same time, changes in the money supply related with expansionary monetary policy also causes inflationary pressures in the long run. The question is in determining whether interest rates or inflation as the main determinant of the Kuala Lumpur Composite Index (KLCI) in both the short- and long run with regards to monetary policy, both internal and external. The study utilises a Vector Error Correction Mechanism (VECM) model lagged at one period to study the causal relationships between the monthly returns of the KLCI with the Overnight Policy Rate (OPR), M3 monetary aggregate and the Effective Federal Fund Rate (EFFR) from January 2010 to June 2019. The study found that in the short run monthly returns were positively influenced by M3 and the previous month’s monthly returns. In the long run the error correction term was significant and implies an overreaction in the stock market towards monetary policy. Unilateral Granger causality was found running from M3 to monthly returns and the EFFR, while OPR Granger caused M3. The study concludes that the money supply side of monetary policy is more significant than interest rates in affecting the stock market, and Bank Negara Malaysia (BNM) should be wary of using monetary policy to influence the stock market due to inflation concerns.