The relationship between financial development and effectiveness of monetary policy: new evidence from ASEAN-3 countries

Abstract

Purpose This paper aims to investigate the relationship between financial development (FD) and monetary policy effectiveness (MPE) on output and inflation in ASEAN-3 countries (Singapore, Malaysia and the Philippines). Design/methodology/approach This study uses an open economy structural vector autoregressive model to generate MPE. Then, an autoregressive distributed lagged (ARDL) model is used to analyze the effect of FD on MPE across countries. Findings The findings revealed that FD plays a different role in MPE across countries. In Malaysia, a more developed financial system tends to reduce the MPE on output, whereas in Singapore, results show that the more developed financial system (stock market capitalization) tends to increase MPE on output. However, in the Philippines, the main results show that the effect of FD (liquid liabilities) upon MPE on output is depending on the policy variable (interest rates or money supply). Originality/value This paper fills this gap by providing the first study of ASEAN-3 countries in examining how effective is a monetary policy in response to the development of the financial market across the country. Second, this paper considers two FD indicators, namely, the banking sector and capital market development in investigating its effect on MPE on output and inflation. Third, the authors construct the MPE in each country using a structural (identified) VAR model by aggregating the response of output growth and inflation rate on monetary policy changes (interest rate and money supply) using impulse–response function. Regarding this, the results of this study provide new empirical evidence and insight into the long debate on the relationship between FD and the MPE.

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“…This outcome implies that a more efficient monetary policy with a less developed financial institution would be more stable in the market system in developing countries. This result was in line with Samba and Mbassi (2016) and Karim et al (2021), who stated that the effect of MPE and FMD on financial stability was a substitute. However, these findings contradicted Ma and Lin (2016), who found a complementary effect of MPE and FMD on financial stability.…”

“…This result implied that the influence of MPE on the credit gap is more prominent in the high-middle income group. This finding was in line with Alpanda and Zubairy (2019) and Karim et al (2021), who found that MPE was the main factor in reducing the credit gap in high-income countries. Furthermore, MPE has increased the overall stability of the financial markets of developing countries, with the effect being greater in high-middle-income nations.…”

Revisiting the financial development and economic growth nexus: empirical evidence from SAARC countries

“…Finally, the coefficient of the money supply is positive and significant at a 5% level. The result shows that one one-unit growth in money supply, there would be, on average, 2.6-unit increase in FD, holding other factors constant, and the findings align with the studies (Khan, 2005; Abdul Karim et al , 2021). The plausible reason is that the increase in the availability of stock of money and the credit opportunities at the lower interest rates thus leads the FD to broaden its role in lending activities.…”

“…The theoretical and empirical support of the demand-following hypothesis can be found in the earlier studies of Ang and McKibbin (2007), Ratsimalahelo and Barry (2010); and Dar and Nain (2023). However, Nain and Kamaiah (2014), Cherif and Dreger (2016) and Abdul Karim et al (2021) did not find any evidence in favour of EG being a significant determinant of FD in the case of emerging countries. The difference in these cited studies could be attributed to the fact that the finance–growth relationship may be subject to some macroeconomic fundamentals, of which inflation could be a major one.…”

Monetary policy effectiveness in Asian developing economies: the moderating role of financial sector development

“…Saraswati et al (2020) revealed that both in the short and long run, financial inclusion showed significant impact on inflation rate, which worked as a proxy for the effectiveness of monetary policy in Indonesia during 2009–2018. In ASEAN 3 countries, Karim et al (2021) found that a more settled stock market capitalization led to improve MP effectiveness on output in Singapore. Further, the study found that in case of the Philippines, the influence of FD (liquid-liabilities) upon MP effectiveness on output is reliant on the interest rate.…”