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Measuring monetary conditions in a small open economy: the case of Malaysia

Author

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  • Muhamed Zulkhibri Abdul Majid

Abstract

Purpose - The purpose of the paper is to gauge the usefulness of the Monetary Condition Index (MCI) and Financial Condition Index (FCI) for the conduct of monetary policy in Malaysia. Design/methodology/approach - The MCI is constructed as the weighted sum of changes in the exchange rate and interest rate from their levels in a chosen base year. The weights are obtained by summing up the coefficients on the lags variables from estimating the determinants of backward-looking aggregate demand. Findings - The paper finds that the movement inflation induces the movement in either interest rate or exchange rate. The result also indicates that the interest rate channel is found to be more powerful than the exchange rate channel. The method in determining the weights for each policy component of the index however indicates some degree of instability due to some external shock affected the exchange rate or the domestic short-term interest rate. Originality/value - In a small open economy with deregulated markets, it is crucial to assess the combined effect of interest rate and exchange rate on monetary conditions and the conduct of monetary policy. Despite the index ability to explain monetary conditions in Malaysia, the estimate of MCI and FCI should be used cautiously. The index does not offer a precise signal on the state of monetary condition in Malaysia.

Suggested Citation

  • Muhamed Zulkhibri Abdul Majid, 2012. "Measuring monetary conditions in a small open economy: the case of Malaysia," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(3), pages 218-231, July.
  • Handle: RePEc:eme:jfeppp:v:4:y:2012:i:3:p:218-231
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    References listed on IDEAS

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    More about this item

    Keywords

    Malaysia; National economy; Monetary policy; Monetary condition index;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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