Monetary policy and foreign shocks

This paper presents a structural vector autoregressive (SVAR) model of monetary policy in Malaysia. The model takes into account the economic and financial conditions in Malaysia‘s two most important trading partners, the United States and Japan. Identification of the SVAR is achieved by imposing zero restrictions non-recursively on the contemporaneous interactions among the variables. This identification leads to the interpretation of an interest rate shock as unanticipated monetary policy. We find that unanticipated monetary policy explains very little of the variability in output and inflation at all forecast horizons but does account for some short run variability in the real exchange rate. Foreign variables explain most of the variability of output and inflation, though domestic credit is important for output at the one quarter horizon. We conclude that foreign shocks are the dominant influence on the macroeconomic performance of Malaysia.