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Monetary policy and inflation targeting in a small open-economy

  • Abdul Karim, Zulkefly
  • Md. Said, Fathin Faezah
  • Jusoh, Mansor
  • Md. Thahir, Md. Zyadi

This paper investigates the transmission mechanism of monetary policy and inflation targeting in a small open-economy by using backward-looking of aggregate supply (AS) and aggregate demand (AD) framework. Since September 1998 until July 2005, Malaysia has implemented a currency pegged to the U.S dollar in responding to the Asian financial crisis. However, since the 21st of July 2005 until at present, the Central Bank of Malaysia (CBM) has eliminated pegging with the U.S dollar and moved to the floating exchange rate with basket currencies framework. This new regime has an essential role to be a primary objective of policy in stabilizing exchange rate against its major trading partners, particularly the regional countries. Nevertheless, maintaining the soundness of interest rate is also important to perceive inflation targeting in increasing economic growth. Therefore, by using a quarterly data from 1991:1 to 2006:1, this study has adopted a traditional structural econometrics model (SEM) to examine the role of inflation targeting in monetary policy transmission in a small-open economy, i.e. Malaysia. The findings indicated that output gap is an important variable in forecasting a domestic inflation rate and interest-rates policy is statistically significant in influencing the output gap. Therefore, the choosing of interest-rates as a policy target is vital in controlling the domestic inflation rate.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23949.

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Date of creation: 20 May 2009
Date of revision: 10 Jan 2010
Handle: RePEc:pra:mprapa:23949
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  1. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  2. Glenn D. Rudebusch & Lars E. O. Svensson, 1999. "Eurosystem monetary targeting: lessons from U.S. data," Working Paper Series 99-13, Federal Reserve Bank of San Francisco.
  3. Guender, Alfred V., 2003. "Optimal monetary policy under inflation targeting based on an instrument rule," Economics Letters, Elsevier, vol. 78(1), pages 55-58, January.
  4. Mise, Emi & Kim, Tae-Hwan & Newbold, Paul, 2005. "On suboptimality of the Hodrick-Prescott filter at time series endpoints," Journal of Macroeconomics, Elsevier, vol. 27(1), pages 53-67, March.
  5. Cheng Hsiao, 1997. "Cointegration and Dynamic Simultaneous Equations Model," Econometrica, Econometric Society, vol. 65(3), pages 647-670, May.
  6. Svensson, Lars E. O., 1998. "Inflation targeting as a monetary policy rule," CFS Working Paper Series 1998/16, Center for Financial Studies (CFS).
  7. Cheng Hsiao, 1997. "Statistical Properties of the Two-Stage Least Squares Estimator Under Cointegration," Review of Economic Studies, Oxford University Press, vol. 64(3), pages 385-398.
  8. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-97, May.
  9. Gerlach, Stefan & Yiu, Matthew S., 2004. "Estimating output gaps in Asia: A cross-country study," Journal of the Japanese and International Economies, Elsevier, vol. 18(1), pages 115-136, March.
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  11. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
  12. Razzak, W., 1997. "The Hodrick-Prescott technique: A smoother versus a filter: An application to New Zealand GDP," Economics Letters, Elsevier, vol. 57(2), pages 163-168, December.
  13. Harvey, A C, et al, 1986. "Stochastic Trends in Dynamic Regression Models: An Application to the Employment-Output Equations," Economic Journal, Royal Economic Society, vol. 96(384), pages 975-85, December.
  14. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2006. "Money Growth, Output Gaps and Inflation at Low and High Frequency: Spectral Estimates for Switzerland," CEPR Discussion Papers 5723, C.E.P.R. Discussion Papers.
  15. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  16. R. Golinelli & R. Rovelli, 2001. "Interest Rate Rules and Inflation Targeting in Three Transition Countries," Working Papers 429, Dipartimento Scienze Economiche, Universita' di Bologna.
  17. Haldane, Andrew G, 1998. "On Inflation Targeting in the United Kingdom," Scottish Journal of Political Economy, Scottish Economic Society, vol. 45(1), pages 1-32, February.
  18. Granville, Brigitte & Mallick, Sushanta, 2006. "Does inflation or currency depreciation drive monetary policy in Russia?," Research in International Business and Finance, Elsevier, vol. 20(2), pages 163-179, June.
  19. Camba-Mendez, Gonzalo & Rodriguez-Palenzuela, Diego, 2003. "Assessment criteria for output gap estimates," Economic Modelling, Elsevier, vol. 20(3), pages 529-562, May.
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