Abstract
Divisia for narrowly and broadly defined monetary aggregate of a developing country Malaysia, are constructed. Unlike the Divisia for narrowly defined monetary aggregate MI, the Divisia for broader defined monetary aggregate M2 does show significant differences in both level and growth rates that signified the degree of the important and usefulness of Divisia index in formulating the monetary policy We ascertained that there exist long-run relationships between all measures of monetary aggregates in this study with inflations. By constructing dynamic error-correction models for all the alternative measures of monetary aggregates. we performed out-of-sample forecasting for three different periods. Analysis of the forecasting statistics indicates that the Divisia monetary aggregates performed better than their simple-sum counterparts in forecasting ability. We conclude that Divisia monetary aggregate namely Divisia M2, has the best forecast ability among all. As such, Divisia M2 can serve as an excellent candidate as a target or indicator in formulating the monetary policy for Malaysia.
Highlights
Malaysia has implemented major financial liberalization since the late 1970s, the first major step being the deregulation of interest rates
M1 is composed of the currency in circulation and demand deposits and M2 includes M1 plus savings deposits (SVD), fixed deposits (FXD), negotiable certificates of deposit (NCD), and repurchase agreements (REPOS)
In this study we developed error-correction models for all alternative measures of monetary aggregates namely Divisia M1, Divisia M2, simple-sum M1 and simple-sum M2
Summary
Malaysia has implemented major financial liberalization since the late 1970s, the first major step being the deregulation of interest rates. Financial deepening and innovation continued steadily and have contributed to the development of a modern and sophisticated financial system in Malaysia (Bank Negara Malaysia, 1999). The negotiable certificates of deposit (NCDs), bankers’ acceptances (BAs), and repurchase agreements (REPOS) were introduced by the central bank in 1979 to increase the variety of money market papers. While NCDs were designed as instruments to mobilize savings, BAs were introduced as an easy financing tool to promote trade. The removal of credit ceilings and liberation of interest rates in the late 1970s paved the way for greater financial sector reforms. Increased globalization of the financial sector has precipitated further changes in the framework of the monetary policy in Malaysia. Simple-sum monetary aggregates may not be the appropriate indicators of the conduct of monetary policy
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