Structural VAR Approach to Malaysian Monetary Policy Framework: Evidence from the Pre- and Post-Asian Crisis Periods

This paper employs a structural vector autoregression (SVAR) model to investigate the monetary policy framework of a small emerging open economy Malaysia, especially how the economy dynamically respond to money, interest rate, exchange rate and foreign shocks. We establish identification conditions to uncover the dynamic effects of monetary policy shocks on various domestic variables. Following the financial crisis in July 1997, Malaysia adopted a pegged exchange regime in September 1998. By analysing the intensity of the responses of the domestic variables to various monetary shocks, we aim to find out whether the Malaysian monetary transmission mechanism has changed in the post-crisis period. Using monthly data from January 1980 to May 2006, a nine variable SVAR model is established to study the dynamic responses of the Malaysian economy to domestic and foreign shocks. The empirical results show notable differences: in the precrisis period, monetary policy and exchange rate shocks significantly affect the output, price, money, interest rate and exchange rate, while, in the post-crisis period, only the money shock tends to have stronger influence on output. Moreover, the domestic monetary policy appear to be far more vulnerable to foreign shocks especially the world commodity price shock and output shock in the post-crisis than in the pre-crisis period. The findings clearly indicate that the crisis has changed the role of the monetary transmission channels in propagating various policy shocks to the real sectors of the Malaysian economy. JEL classification: C32, F41, E52