Is Malaysia exempted from the impossible trinity? An empirical analysis for an emerging market

Abstract

This paper estimates offset and sterilization coefficients in Malaysia with the objective to assess the relevance of the Impossible Trinity for policy. The paper finds that Malaysia had scope for independent monetary policy in the short run; but in the longer run only under managed floating or capital controls. The loss of long-run monetary autonomy under peg/open capital was in line with the trinity, and may be one reason the peg was eventually abandoned for managed floating in year 2005. The results suggest that managed floating with sterilizations could be a viable monetary strategy for emerging markets facing volatile capital flows.

Keywords:

• offset coefficient
• sterilization coefficient
• monetary autonomy
• impossible trinity
• Malaysia

JEL classification:

• E52
• F41

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. This argument is in line with Cavoli (2009) who examined a range of policy configurations for countries which have a fear of floating its exchange rate.

2. The author was an assistant governor of Malaysia’s Central Bank during the period 1996–2004.

3. The controls covered some aspects of portfolio investment and restriction on capital outflows. FDI, trade and FDI-related repatriations by non-residents were not covered.

4. A recent study by Goh and McNown (2015) examined the interaction between the Malaysian and US interest rates during three different sub-periods. The study found that there is a loss of monetary autonomy in the long run during the pegged/open capital regime.

5. The other form of examining monetary autonomy is to examine the responsiveness of domestic interest rates to changes in the base country’s interest rates. This approach was taken by Reade and Volz (2010, 2011), Edison and MacDonald (2000) and Klein and Shambaugh (2013).

6. Like many countries, BNM does not make intervention and sterilization data public. However, occasionally the bank will report sterilization activity in the BNM annual report.

7. Ouyang and Rajan (2005) and Ouyang, Rajan, and Willett (2010) for example, assume that all the reserves are held in US dollars and adjust the reserves for changes in the bilateral US dollar rates.

8. See BNM Annual Report, various series after 1999.

9. Monthly balance sheet of BNM is available at Monthly Statistics Bulletin, BNM online, http://www.bnm.gov.my/index.php?ch=109&pg=294&ac=211&yr=2010&mth=7&eId=box1

10. These data are no longer available after 2009 as BNM has changed the format of the balance of payment to BPM6.

11. During 1988–1999, SRR was gradually increased from 3.5% to 13.5% to curb inflationary pressures. In 1998, SRR was reduced four times to 4% by 16 September 1998 in response to ACC.

12. In Malaysia, government deposits and pension funds can form a sizeable part of money supply. It is a common practice for the authority to shift the EPF fund from the commercial banks to the central bank (Lim 1998).

13. Another good choice of instrument is the lag of independent variables.

14. Another good instrumental variable is the dummy variable which captures policy changes. BNM sterilized heavily in 1993 to counter the surge in portfolio flows which led to a doubling of the stock market in that year.

15. Ouyang and Rajan (2005) and Ouyang et al. (2010) used the modified Brissimis, Gibson, and Tsakalotos (2002) model to estimate the offset and sterilization coefficients for Taiwan (1990q1–2004q4), Singapore (1990q1:2004q4) and China (2000.6–2008.9). For Taiwan, the estimated offset coefficient is 0.86–0.92, while the estimated sterilization coefficient is just above 1. For Singapore, the estimated offset and sterilization coefficients are around 0.87 and 1, respectively. For China, they found a low offset coefficient around 0.5 and are statistically significant, indicating a moderate degree of capital mobility due to the existence of capital controls in China. The estimated sterilization coefficients are also highly statistically significant at around 1, suggesting that the PBC has heavily sterilized its reserve accumulations in the last 9 years.

16. Liu, Chang, and Su (2013) suggested that sterilization operation is another issue of China’s government to maintain the independence of monetary policy.

17. Gan and Kwek (1994) estimate the degree of sterilization of foreign exchange intervention using a simple response function that is change of NDA is a function of change of NFA and lagged of the change of NDA itself. They estimate the model from 1973 to 1993. They found the sterilization coefficient is 0.989, significantly different from −1.

Additional information

Notes on contributors

Ewe Ghee Lim

Dr Ewe Ghee Lim is a graduate of Yale University and the University of California, Davis, USA. He served as senior economist at the International Monetary Fund (IMF), Washington, DC, for 23 years. He is currently attached at the Faculty of Economics, University Malaya, Kuala Lumpur, as senior research fellow. He wrote papers for IMF Working Paper. His paper on the ‘Determinants of, and the relation between foreign direct investment and growth: a summary of the recent literature’ IMF Working Paper 01/175 is well cited by other researchers.

Soo Khoon Goh

Soo Khoon Goh is currently attached at the Centre for Policy Research and International Studies in Universiti Sains Malaysia (Science University of Malaysia), Penang, Malaysia. She has a B. Economics from University Malaya, Malaysia, M.Sc. in Economics from University of Colorado Boulder, USA, and a Ph.D. in Economics from the University of Melbourne, Australia. Her main research interests lie in macroeconomics and international economics. Her latest publication with Professor Robert McNown is available at International Review of Economics and Finance 2015, vol 35, pp. 292–303. She is also a Fulbright Scholar, 2012–2013.