Responses of monetary policies to oil price changes in Malaysia

Abstract

Malaysia is one of the net oil-exporting countries that the government budget depends highly on oil revenues. The dependency on uncertain revenues faces the economic development of the country with significant challenges. Therefore, the monetary authorities need to be aware of the importance and the role of their policies on the economy in response to changes in global oil prices. For this purpose, this paper simulates the responses of monetary policies to changes in global oil prices in Malaysia using a financial computable general equilibrium (CGE) model. It considers both changes (a rise and a fall) in global oil prices. The simulation results indicated that the Malaysian economy, as a whole, and the majority of industries gain from oil price rise and lose from oil price fall. Both shocks lead to the reallocation of resources and influence the financial part of the economy. Results also showed that tightened monetary policies are not able to reduce the negative effects of both shocks on economic growth and industrial output while the expansionary policies, particularly the combination of interest rate and reserve ratio reductions, are effective and are beneficial for economic growth and industrial output of Malaysia. If the government target is minimizing the rate of inflation, the effective policy in response to both global oil price changes is the reduction in interest rate. However, when the government target is more investment and labor employment, the effective policy is the reduction in reserve ratio rate in response to both oil price changes.