Structural vector autoregressive analysis of monetary policy in Malaysia

Abstract

This thesis comprises three empirical studies of the transmission mechanism of monetary policy in Malaysia. Structural vector autoregression (SVAR) models – with non-recursive identification schemes – are employed in each of the studies. Chapter 2 develops a model to evaluate the relative importance of various monetary transmission mechanisms; the credit, asset price and the exchange rate channels. The identifying restrictions used in the model are successful in eliminating the widespread price and exchange rate puzzles. The evidence suggests that interest rate, credit and asset price shocks all have significant real effects on the Malaysian economy. Use of a transmission shutdown procedure indicates the credit channel plays a significant role in transmitting an innovation in the policy rate to domestic output (over the longer term). The exchange rate channel plays a similar role in the transmission of monetary shocks to the inflation rate. Chapter 3 extends the initial SVAR model for Malaysia by investigating sectoral effects of monetary policy. The findings reveal that shocks to the interest rate, credit, asset prices and the exchange rate produce quite different responses in sectoral outputs. The credit channel is found to play the most important role in transmitting a policy rate shock to the mining, manufacturing and service sectors, while asset prices are a relatively important channel in affecting the agriculture and construction sectors. Chapter 4 investigates the relative importance of international and domestic shocks in affecting the Malaysian economy. Three models are estimated. The first model combines US and Japanese variables to represent the world economy. As a comparison, the other two models use US and Japanese variables by themselves, to capture the external sector. The main findings suggest that domestic shocks play the major role in determining short-run variation in real and financial variables in Malaysia. In the medium to longer term is where foreign shocks play a more important role. Relative to the use of a weighted average of US and Japanese variables, use of US or the Japanese variables alone to represent foreign sector, frequently produces quite different estimates of the influence of foreign (and domestic) shocks on the Malaysian economy.