International Disturbances and Domestic Macroeconomic Fluctuations in Malaysia

Abstract

This article analyses international influences, as represented by U.S. macroeconomic variables, on economic fluctuations in a small open economy, Malaysia. The analysis is based on variance decompositions and impulse-response functions generated from a vector autoregressive model. The results indicate that shocks in U.S. real activity and monetary policy are transmitted to Malaysian real activity. Additionally, apart from domestic monetary influences on Malaysian inflation, evidence for the lagged transmission of U.S. inflation to Malaysian inflation is found. The results highlight the central role played by exchange rates in explaining domestic macroeconomic fluctuations, and more specifically, our results point towards contractionary and inflationary currency depreciation shocks. Exchange rate depreciation also leads to monetary expansion. Thus, since the exchange rate responds to U.S. real output and inflation, exchange rate changes may be viewed as an important channel of shock transmissions to the Malaysian economy. From a policy point of view, these results stress the importance of exchange rate stability for the Malaysian economy.