Mala Raghavan

Structural VAR models for Malaysian monetary policy analysis during the pre- and post-1997 Asian crisis periods

This article conducts an in-depth investigation into building a Structural Vector Autoregression (SVAR) model and analysing the Malaysian monetary policy. Considerable attention is paid to: (i) the selection of foreign, policy and target variables; (ii) establish identifying restrictions and improve the estimates of impulse response functions; (iii) assess the importance of intermediate channels in transmitting monetary policy mechanism; and (iv) the way in which the 1997 Asian financial crisis affected the working of monetary policy. Malaysia is an interesting small open economy to study because, following this crisis, the government imposed capital and exchange rate control measures. The overall results suggest that the crisis and the subsequent major shift in the exchange rate regime have significantly affected the Malaysian ‘Black Box’. In the pre-crisis period, domestic variables appear to be more vulnerable to foreign monetary shocks. Further, the exchange rate played a significant role in transmitting the interest rate shocks, whereas credit and asset prices helped to propagate the money shock. In the post-crisis period however, asset prices play a more domineering role in intensifying the effects of both interest rate and money shocks on output, and the economy was insulated from foreign shocks.

Canadian monetary policy analysis using a structural VARMA model

This paper builds a structural VARMA (SVARMA) model for investigating Canadian monetary policy. Despite the support for a VARMA model for monetary policy analysis, the traditional VAR and SVAR models have predominantly been used in the literature mainly due to difficulties associated with the identification and estimation of such a model. Using the scalar component model (SCM) proposed by Athanasopoulos and Vahid (2008a), this paper first identifies a VARMA model and then constructs a SVARMA model for Canadian monetary policy. We included the SVAR model in our study for a comparison purpose. Relative to this model, the impulse responses generated by the SVARMA model appear to be consistent with those predicted by various economic theoretical models, and solves the economic puzzles found commonly in the empirical literature on monetary policy. The successful construction and implementation of the SVARMA model for Canadian monetary policy analysis along with its promising impulse responses, indicate the suitability of this framework for small open economies.

International transmissions to Australia: The Roles of the USA and Euro Area

This paper examines the influences of the worlds two largest developed economies, namely the USA and the Euro area, on Australia as an exemplar of a small open economy. To do so, we specify and estimate a structural VAR with bilateral linkages between the two large economies, and allow shocks originating in either to affect the Australian economy. More specifically, we show the role of foreign output shocks, the differential effects of USA- or Euro-area-sourced inflation and interest rate shocks on the Australian economy, and the relative unimportance of these foreign shocks to variations in the value of the Australian currency.

Impact of capital control measures on the Malaysian stock market: A multiresolution analysis

Purpose - The purpose of this paper is to examine the extent to which the capital control measures implemented by the Malaysian central bank in late 1998 had an influence on segmenting the Malaysian equity market from other major equity markets. Design/methodology/approach - The S&P 500, the Nikkei 225 Index, the STI Index and the KLSE Composite Index are considered. The discrete wavelet transform technique – “Haar” is employed to decompose the series into various time scales during the pre- and post-capital control periods in Malaysia. The decomposed series are then used to estimate the interdependence between KLSE Composite Index with the other three markets at various time scales. Findings - The empirical findings support three conclusions. First, in the pre-capital control period, Singapore is the most influential market followed by the US across all time scales in transmitting news into Malaysia. Second, after the imposition of capital controls, the spillover effects from Singapore to Malaysia have declined substantially, suggesting a reduced integration between these two markets. Finally, in the post-capital control period, all three markets appear to be imparting a similar but moderate level of influence on the Malaysian market. Research limitations/implications - To explore the return and volatility spillovers, the use of return and volatility series at different time scales provided a greater level of insight into the dynamics than the standard approaches which employ only one series in the time domain. Originality/value - The results from this paper will have potential implications for asset allocation, the pricing of domestic securities, the implementation of global hedging and trading strategies and the evaluation of regulatory proposals to restrict international capital flows.

Should ASEAN-5 monetary policy-makers act pre-emptively against stock market bubbles?

Stock market rises and asset price inflation in ASEAN economies have raised the question of whether monetary authorities in these economies should act pre-emptively against these rising trends to prevent impending financial crises. Using structural vector error correction models (SVECMs) which incorporate mixed data characteristics, we examine the effects and interactions between monetary policy and stock market shocks for Singapore, Malaysia, Thailand, Indonesia and the Philippines. The results suggest that monetary policy focused on the stock market detracts from price stability objectives, in particular because containing a stock market bubble may inadvertently depress output and inflation.

Macro-financial effects of portfolio flows: Malaysia’s experience

This paper studies the causes and effects of portfolio flows in Malaysia. We use Structural Vector Autoregression (SVAR) and Autoregressive Distributed Lag (ARDL) models to analyse the interactions among portfolio flows, global and domestic macro and financial variables within a common empirical framework. Three findings emerge: First, the SVAR estimations show that global and domestic factors play transitory roles in driving Malaysia’s net portfolio flows. A subsample analysis from the ARDL model highlights that domestic factors play an increasingly important role in attracting portfolio inflows as Malaysia liberalised its exchange rate regime and capital flow restrictions. Second, higher net portfolio flows lead to exchange rate appreciation, higher equity prices and credit expansion. The effects are visible in the exchange rate, followed by equity prices and credit. Third, in the transmission of higher portfolio flows to growth, the positive effects from higher equity prices and credit are partially offset by the dampening effect from the appreciating exchange rate on output. While the contribution of portfolio flow’s effects on output variance is low, the impulse responses of output does change to portfolio flow shocks, suggesting that portfolio flows are tail risks to growth and that the risks magnify when the flows are large and volatile.

Econometric analysis of Malaysian monetary policy

Over the years, many economies around the world have evolved in line with globalization and liberalization processes and have witnessed widespread changes in their conduct of monetary policy and the choice of monetary policy regimes. These processes have opened up new avenues and increased opportunities for financial market developments with greater financial integration and strong capital flows. The changing economic and financial environments have made modelling monetary policy and the identification of monetary policy shocks very challenging, particularly in small emerging open economies. To date, not much research work has been carried out on these economies, and this thesis attempts to fill this gap by addressing the problems associated with modelling monetary policy and the complexities involved in estimating monetary policy shocks and impulse response functions. In this thesis, we investigate the monetary transmission mechanism of the Malaysian economy, which provides an interesting case study to examine the effects of monetary policy on the real sectors of the economy under different exchange rate regimes. Malaysia adopted a managed float exchange rate regime prior to the 1997 Asian financial crisis and subsequently a pegged (to US dollar) exchange rate regime following the crisis. The specific aims of this research are: (i) To establish the necessary identification conditions to uncover Malaysian monetary policy shocks; (ii) To examine whether or not the identified model can resolve economic puzzles commonly found in monetary policy empirical literature; (iii) To evaluate the effectiveness of monetary policies on price levels and economic activities during the pre- and post-1997 Asian financial crisis periods; and (iv) To assess the strength of various monetary transmission channels such as interest rates, monetary aggregates, credits, asset prices and exchange rates in propagating monetary policy shocks under different exchange rate regimes. To achieve the above aims, we employ three different modelling strategies: (i) the vector autoregressive (VAR); (ii) the structural vector autoregressive (SVAR); and (iii) the vector autoregressive moving average (VARMA) models. The traditional VAR approach is used as a first step to conduct some preliminary analysis, and to develop and analyze the effects of Malaysian monetary policy. Subsequently, the SVAR models are used to address issues concerning the contemporaneous relationships between Malaysian macroeconomic variables and policy instruments. We establish identification restrictions that are broadly consistent with economic theory and stylized facts that are evident in prior empirical research findings. One of the important characteristics of our identified SVAR model is the set of foreign block exogeneity restrictions which we impose to reflect the fact that small open economies do not influence large economies. Further, under the managed and pegged exchange rate systems, we uncover the importance of various monetary channels through which monetary policy shocks affect the Malaysian economy. The VARMA models are found to be superior to the VAR-type models for forecasting economic and financial variables. However, VARMA models are rarely used in empirical studies of monetary policy analysis. We are among the first to apply this methodology to investigate the responses of Malaysian variables to various monetary shocks and to assess whether they are consistent with prior theoretical expectations and stylized facts. The attractiveness of the VARMA model is that its impulse response functions reveal the expected monetary policy effects on the Malaysian economy, particularly in the postcrisis period under the pegged exchange rate system. On the other hand, the VAR and SVAR models fail to generate reliable impulse responses in some cases. The overall results suggest that the crisis, and a subsequent major shift in the exchange rate regime, have affected the Malaysian monetary transmission mechanism. Malaysian domestic variables are more sensitive and volatile to both domestic and foreign monetary shocks under the managed float exchange rate system than under the fixed exchange rate system. Hence, it is apparent that the stringent capital control measures undertaken by the government in the post-crisis period have insulated the Malaysian economy to some extent against foreign shocks and have provided the desired monetary autonomy. Considering some disparities in the effects of monetary policy on the Malaysian economy during the pre- and post-crisis periods, it is essential that policy makers understand how the economic transformation, the openness of the economy and the growing integration with external economies affects the nature of the monetary transmission mechanism. In our investigations, we uncover how various transmission channels work and we believe the outcome of our study can help the Malaysian Central Bank to steer the economy in the right direction, so that monetary policy can still remain an effective policy measure in achieving sustainable economic growth and price stability. In addition, the methodologies used in this thesis and the empirical findings will also enhance future research on similar small emerging open economies in devising appropriate monetary policy strategies under different policy regimes.