Interest Rates Targeting of Monetary Policy: An Open Economy SVAR Study of Malaysia

Abstract

This paper examines the implementation of monetary policy during the interest rates targeting in a small-open economy (i.e. Malaysia) by using an open-economy structural VAR (SVAR) study. It tests the effect of foreign shocks upon domestic macroeconomic fluctuations and monetary policy, and examines how effective monetary policy is in influencing macroeconomic variables. The results show that during interest rates targeting, monetary policy plays a significant role in affecting macroeconomics variables. This finding suggests that monetary policy has an important role as a stabilization policy in a small-open economy.

Financial Development and the Effectiveness of Monetary Policy: New Evidence from Malaysia

“…Previous studies that supported finance-led growth nexus in Malaysia included Ansari (2002), Ang and McKibbin (2007), Ang (2008), and Karim et al (2008). Whereas, studies that have examined the role of monetary policy on economic activity included Azali and Matthews (1999), Ibrahim (2005), Tang (2006), Karim et al (2011), and Karim and Karim (2014). These studies have generally confirmed the real effects of monetary policy in Malaysia.…”

“…Money supply (M3) was assumed to respond contemporaneously to domestic output, inflation, and interest rates. This approach in identifying assumption was used by Zaidi et al (2013), Karim et al (2013) and Zaidi et al (2018), and Karim and Karim (2014). Since exchange rate (REER) was considered a fast-moving variable, it was thus assumed that REER also responded contemporaneously to all variables in the system.…”

“…Since exchange rate (REER) was considered a fast-moving variable, it was thus assumed that REER also responded contemporaneously to all variables in the system. This approach was used by Zaidi and Fisher (2010), Karim et al (2013), Karim and Karim (2014), and Zaidi and Karim (2014). The matrix in Equation 5 shows that the number of free parameters are fewer than the zero restrictions, which implied that the SVAR model is over identified.…”

“…Thirdly, MPE is generated using structural vector auto regressive (SVAR) model by accumulating the response of output growth and inflation rate on monetary policy changes (interest rate and money supply) using impulse-response function. The previous studies on monetary policy in Malaysia, such as Azali and Matthews (1999), Ibrahim (2005), Tang (2006), Karim et al (2011), Karim and Karim (2014), and Xiaohui and Masron (2014) in China, have not sufficiently examined empirically the effect of FD on MPE. Finally, the autoregressive distributed lag (ARDL) model (bounds test) is used for further investigation into the link between FD (liquid liabilities and stock market capitalisation) and MPE on output and inflation.…”

Relative Price Effects of Monetary Policy Shock in Malaysia: A Svar Study

“…In Malaysia context, studies relating to monetary policy analysis have focused upon the effect of monetary policy on aggregate output (for example, Azali and Matthews, 1999;Ibrahim, 2005;Tang, 2006;Karim and Karim, 2014). Azali and Matthews (1999) employs a closed economy SVAR model, and find that during the pre-liberalization period, the bank credit shock had more impact compared with money shock in explaining output variability.…”