Article

THE RELATIVE IMPORTANCE OF MONETARY POLICY TRANSMISSION CHANNELS IN MALAYSIA

09/2006;
Source: RePEc

ABSTRACT

This paper investigates the relative strength of four monetary policy transmission channels (exchange rate, asset price, interest rate and credit) in Malaysia using a 12-variable open economy VAR model. By comparing the baseline impulse response with the constrained impulse response where a particular channel is being switched off, the interest rate channel is found to be the most important in influencing output and inflation in the horizon of about two years, and the credit channel beyond that. The asset price channel is also relevant in the shorter-horizon, more so than the exchange rate channel, particularly in influencing output. For inflation, the exchange rate channel is more relevant than the asset price channel.

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    • "6 The remaining three variables are used to represent other three transmission channels, Credit channel has been represented by the total amount of loans provided by scheduled banks to private sector (CPS). This variable will allow us to capture both elements of bank lending and balance sheet effects in credit channel (Tang, 2006). The Karachi stock exchange 100 index (KSEI) is used as a bench mark index to represent asset price channel and nominal effective exchange rates (NEER) exchange rate channel, any decrease in NEER will represent depreciation of domestic currency against the basket of currencies for all major trading countries to Pakistan and vice versa. "
    [Show abstract] [Hide abstract] ABSTRACT: The objective of this study is to investigate the relative importance of four transmission channels (i.e. interest rate, credit, exchange rate and asset price channel) of monetary policy in achieving the internal balance for a small open-economy of Pakistan. This study has employed open-economy Structural vector autoregressive (SVAR) model with non-recursive identification. This method is undertaken to analyze the effects of external shocks on the domestic macroeconomic variables and on domestic monetary policy. The shutdown method in SVAR has also been used to gauge the relative importance of each channel. The results show that foreign shocks have contractionary effects on domestic economy and monetary policy. Interest rate channel has been less important on inflation rate than asset price and credit channel, although it is found important in output variations. Exchange rate channel has been found least important in both cases of inflation and output in Pakistan. This study has found that central bank of Pakistan can only utilize interest rate channel when it targets output, whereas to control inflation rate the asset price channel is relatively more useful.
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    • "For example, in the Malaysian context, Azali and Matthews (1999) and Ibrahim (2005) use a closed economy model in examining the effect of domestic monetary policy shocks on economic activities, and find that there is a real effect of monetary policy. In comparison, Tang (2006) employs an open-economy recursive VAR model in examining the relative importance of the monetary policy transmission mechanism channels (interest rates, credit, asset price, and exchange rate channel). His study concludes that the interest rate channel plays a pivotal role in influencing output and inflation. "
    [Show abstract] [Hide abstract] ABSTRACT: This paper examines the relative importance of Singapore, US and Japanese macroeconomic shocks on Malaysian economy. Employing structural vector auto regression (SVAR) model with a sign restriction approach, the study estimates four models. Each model consists of four domestic macroeconomic variables (output, inflation, interest rate and exchange rate) and three foreign variables (output, inflation and interest rate) of US, Japan, Singapore and the all countries trade-weighted variables, respectively. The results of the study reveal that, relative to domestic shocks, foreign shocks appear to play more prominent role in influencing domestic macroeconomic variables. Among the three foreign countries being investigated, the effect of shock of Singapore is the most dominant. The US effect comes second and the Japanese effect comes last. When Singapore's variables are the only foreign factors in the system, their shocks bring about significant variation to Malaysian variables especially the output. Consequently, in modeling the effect of foreign factors on Malaysian economy, Singapore effect should be taken into account. This is important as Singapore is not only one of Malaysia's long-term major trading partners, but it is also one of the Malaysia's closest neighbors by geographical distance.
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    • "As defined, an increase in the exchange rate means that the domestic currency which is the Ringgit Malaysia (RM) appreciates relative to the currencies of its major trading partners. A similar variable has been used by Domac (1999); however Ibrahim (2005) uses the nominal effective exchange rate, while Tang (2006) uses the nominal bilateral RM/USD exchange rate. "
    [Show abstract] [Hide abstract] ABSTRACT: Studies on Malaysia monetary policy mostly examine the effect of monetary policy change on output and inflation in aggregate terms. While sectoral output effects of monetary policy have also been investigated, there is however a lack in the study on the effect of policy change on disaggregated inflation. This paper attempts to examine the later issue by employing structural vector autoregressive (SVAR) model. By estimating the model separately for each sub-group of Malaysian consumer price index, we find that a modest monetary policy shock results in varying degree of responses in disaggregated inflation. In other words, some sub-group inflation react instantly while others respond sluggishly to a monetary policy shock. In contrast to aggregate inflation response, there is also evidence of price puzzle. The results give some insight to monetary authority on how to control inflation in aggregate as well as in disaggregate terms and in turn manage the cost of living issues in Malaysia.
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