Testing the Effectiveness of Monetary Policy in Malaysia Using Alternative Monetary Aggregation

Leong, Choi-Meng and Puah, Chin-Hong and Abu Mansor, Shazali and Evan, Lau (2008): Testing the Effectiveness of Monetary Policy in Malaysia Using Alternative Monetary Aggregation.

Abstract

The capability of monetary aggregates to generate stable link with fundamental economic indicators verifies the effectiveness of monetary targeting. However, traditional monetary aggregates have become flawed when financial reforms take place. As official monetary aggregates fail to maintain stable link with crucial economic indicators in Malaysia, monetary targeting has been substituted by interest rate targeting. Therefore, Divisia monetary aggregates, which are considered more superior than the simple sum counterparts are used in the investigation for the case of Malaysia. The findings imply that Divisia M2 money demand is stable and is capable to generate appropriate coefficients with correct signs for the variables included. Thus, Divisia money has shed new light on the usefulness of monetary targeting in formulating monetary policy in Malaysia.

• Item Type: MPRA Paper
• Language: English
• Keywords: Divisia money; Money demand; Error-correction model
• Subjects: C - Mathematical and Quantitative Methods > C4 - Econometric and Statistical Methods: Special Topics > C43 - Index Numbers and Aggregation; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money

References

Ahmad, M. (2001) Demand for money in Bangladesh: An econometric investigation into some basic issues, The Indian Economic Journal, 48, pp. 84-89.

Anderson, R.G., Jones, B.E. & Nesmith, T.D. (1997a) Introduction to the St. Louis monetary services index project, Federal Reserve Bank of St. Louis Review, January/February, pp. 25-29.

Anderson, R.G., Jones, B.E. & Nesmith, T.D. (1997b) Building new monetary services indexes: Concepts, data and methods, Federal Reserve Bank of St. Louis Review, January/February, pp. 53-82.

Anderson, R.G., Jones, B.E. & Nesmith, T.D. (1997c) Building new monetary services indexes: Concepts, data and methods, Federal Reserve Bank of St. Louis Review, January/February, pp. 53-82.

Arize, A.C., Malindretos, J. & Grivoyannis, E.C. (2005) Inflation-rate volatility and money demand: Evidence from less developed countries, International Review of Economics and Finance, 14, pp. 57-80.

Bank Negara Malaysia (1999) The Central Bank and the Financial System in Malaysia. Kuala Lumpur: Bank Negara Malaysia.

Bank Negara Malaysia, Quarterly Economic Bulletin, various issues. Kuala Lumpur: Bank Negara Malaysia.

Barnett, W.A. (1978) The user cost of money, Economic Letters, 1, pp. 145-149.

Barnett, W.A. (1980) Economic monetary aggregates: An application of index number and aggregation theory, Journal of Econometrics, 14, pp. 11-48.

Barnett, W.A. & Chang, H.K. (2005) Exchange rate determination from monetary fundamentals: An aggregation theoretic approach, Working Papers Series in Theoretical and Applied Economics No.2002513.

Belongia, M.T. (1996) Measurement matters: Recent results from monetary economics reexamined, Journal of Political Economy, 104, pp. 1065-1083.

Binner, J.M., Bissoondeeal, R.K. & Mullineux, A.W. (2005) A composite leading indicator of the inflation cycle for Euro area, Applied Economics, 37, pp. 1257-1266.

Caruso, M. (2006) Stock market fluctuations and money demand in Italy, 1913-2003, Economic Notes, 35, pp. 1-47.

Dahalan, J., Sharma, S.C. & Sylwester, K. (2005) Divisia monetary aggregates and money demand for Malaysia, Journal of Asian Economics, 15, pp. 1137-1153.

Dickey, D.A. & Fuller, W.A. (1981) Likelihood ratio statistics for autoregressive times series with a unit root, Journal of the American Statistical Association, 74, pp. 427-431.

Drake, L. & Fleissig, A. (2004) Admissible monetary aggregates and UK inflation targeting, Money Macro and Finance (MMF) Research Group Conference 2004 No.2.

Engle, R.E. & Granger, C.W. (1987) Cointegration and error correction: Representation, estimation and testing, Econometrica, 55, pp. 251-276.

Habibullah, M.S. (1999) Rationale for divisia monetary aggregates in ‘deregulated’ Asian developing countries, in: M.S. Habibullah (eds) Divisia monetary aggregates and economic activities in Asian developing economics, pp. 67-111 (Aldershot: Ashgate Publishing Limited).

Hendry, D.F. & Ericsson, N. (1991) An economic analysis of UK, in: M. Friedman & A.J. Schwartz (eds), American Economic Review, 81, pp. 8-39.

Hueng, C.J. (1998) The demand for money in an open economy: Some evidence for Canada, North American Journal of Economics & Finance, 9, pp. 15-31.

Ibrahim, M.H. (2001) Financial factors and the empirical behavior of money demand: A case study of Malaysia, International Economic Journal, 15, pp. 55-72.

International Monetary Fund, International Financial Statistics, various issues. Washington, D.C.: IMF.

Johansen, S. (1988) Statistical analysis of cointegration vectors, Journal of Economic Dynamics and Control, 12, pp. 231-254.

Johansen, S. & Juselius, K. (1990) Maximum likelihood estimation and inference on cointegration - With applications to the demand for money, Oxford Bulletin of Economics and Statistical, 52, pp. 169-210.

Klein, B. (1974) Competitive interest payments on bank deposits and the long-run demand for money, American Economic Review, 64, pp. 931-949.

Kot, A. (2004) The impact of monetization on the money demand in Poland, Makroekonomia, July, pp. 31-37.

la Cour, L.F. (2006) The problem of measuring ‘money’: Results from an analysis of Divisia monetary aggregates for Denmark. In M.T. Belongia and J.M. Binner (eds) Money, Measurement and Computation, pp. 185-210 (New York: Palgrave MacMillan).

Marashdeh, O. (1997, November) The demand of money in an open economy: The case of Malaysia. Paper presented at the Southern Finance Association Annual Meeting, Baltimore, Maryland.

Spencer, P. (1997) Monetary integration and currency substitution in the EMS: The case for a European monetary aggregate, European Economic Review, 41, pp. 1403-1419.

Wu, C.S., Lin, J.L., Tiao, G.C. & Cho, D.D. (2005) Is money demand in Taiwan stable? Economic Modelling, 22, pp. 327-346.

Yu, Q. & Tsui, A.K. (2000) Monetary services and money demand in China, China Economic Review, 11, pp. 134-148.