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

Abstract

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.

Keywords:

• identification
• impulse responses
• open economy
• monetary policy
• SVAR models
• intermediate channels

JEL Classification:

• C32
• E52
• F41

Acknowledgements

The authors wish to thank Arian Pagan, Vance Martin, Mardi Dungey, and the participants of the 2008 ESAM, Wellington, and the members of Central Banks of Australia and NZ for their constructive comments on the earlier version of this article. Athanasopoulos acknowledges financial support from Australian Research Council grant DP0984399.

Notes

¹ For extensive reviews, see Sims (1992), Leeper et al. (1996), Zha (1997), Bagliano and Favero (1998) and Christiano et al. (1999).