The Changing Malaysian Financial Environment and the Effects on Its Monetary Policy Transmission Mechanism

In recent times, economists concur that economy's response to monetary policy is somewhat weaker then they were in the past. However, the cause of such change remains an open issue. One plausible reason for this change could be attributed to the financial reform processes that have brought significant structural changes in the financial systems through financial innovation, integration and market development. As a result, these changes in the financial systems have prompted a reassessment of the transmission mechanism through which monetary policy affects the final variables of income and prices. In the Malaysian experience, major reforms were undertaken in the 90s that have opened up new avenues and opportunities for its financial market development. However, the changing financial environment posed great challenge to Bank Negara in the formulation and implementation of its monetary policy. This paper investigates to what extent the liberalisation processes in Malaysia have affected the transmission channels of monetary policy and their ability to achieve the ultimate goals of sustainable real income growth and price stability. The Johansen co-integrating technique and the error correction model is used to analyse the long run and the short run properties of the financial variables such as monetary aggregates, credit aggregates and interest rates with respect to ultimate goal variables. The empirical findings suggest that the credit and monetary aggregates are no longer reliable as the main intermediate target. Conversely, interest rates seem to have gained a significant role in the post reform period