The distributional consequences of monetary policy : evidence from Malaysia

The author provides a descriptive analysis of credit and monetary policies in Malaysia and investigates the distributional consequences of monetary policy there by focusing on small and medium-size industries and large manufacturing firms. The author suggests that"payoff"or"default"risk - as captured by the spread between safe and risky debt - is still well above its pre-crisis level, underscoring the increased agency costs of external finance. The decline in lending activity in the first half of 1998 can be attributed to the reduced supply of bank credit relative to demand. Empirical results from vector autoregression on analysis demonstrates that monetary tightening disproportionately affects small and medium-sized enterprises. Moreover, monetary shocks contribute substantially more to small and medium-size firms'variance of production (71 percent) than to that of large manufacturing firms (30 percent). These findings corroborate the notion that small and medium-size industries face greater market imperfection, which in turn magnify the effects of a given policy shift. Policymakers should weigh the distributional consequences of policy actions and should consider measures to alleviate the disproportionate impact that market imperfections have on small and medium-size industries. Measures to alleviate information asymmetry in credit markets - including the promotion of cooperative or mutual guarantee schemes for small and medium-size enterprises -- are one useful option. Groups of firms in Southern Europe have made wide use of mutual guarantee schemes - usually within a specific industry - to provide a privately organized"insurance system"for lending banks that allows the banks to rely less on the assets of individual companies within the group in making loan decisions. The pooling effects of such a system would reduce the risk to the bank of default and would give members of the society an incentive to reveal information to the society that they might hesitate to give to the bank.