Abstract
This paper attempts to determine whether Divisia Monetary Aggregates is a superior monetary instrument in Malaysia where monetary targeting has been replaced by interest rate targeting due to the inadequacy of the monetary aggregates in predicting imperative economic activities. Is there any discernible evidence to suggest that Divisia monetary Aggregates possess significant relationship with the macroeconomics indicators? The empirical results in this study indicate that Divisia M2 performs excellently in the money demand function of Malaysia that incorporated the financial reform and financial development variables. The significance of Divisia money validates the usefulness of monetary targeting to formulate monetary policy in Malaysia.
Highlights
The money demand function is significant, especially to central banks, as it serves as a channel to detect the money supply growth targets in the medium term as well as to monitor the total liquidity via interest rate and reserve money manipulation (Treichel 1997)
An unstable demand for money function is found as a consequence of financial reforms and the emergence of new financial assets, which may result in the mismatch of the monetary growth targets and real economic growth; a diversion of interest rate targets with the prearranged money supply growth; and erroneously targeted monetary aggregate to replicate the total liquidity of an economy (Treichel 1997)
Monetary targeting that was utilized as the policy target in some countries has been substituted by different types of policy targets, among others, inflation targeting and interest rate targeting, that can better predict the movements of the important macroeconomic indicators
Summary
The money demand function is significant, especially to central banks, as it serves as a channel to detect the money supply growth targets in the medium term as well as to monitor the total liquidity via interest rate and reserve money manipulation (Treichel 1997). An unstable demand for money function is found as a consequence of financial reforms and the emergence of new financial assets, which may result in the mismatch of the monetary growth targets and real economic growth; a diversion of interest rate targets with the prearranged money supply growth; and erroneously targeted monetary aggregate to replicate the total liquidity of an economy (Treichel 1997). The financial sector became more deregulated and market-oriented, and further enhanced liberalization and international integration (Bank Negara Malaysia 2011). The performance of monetary targeting has been affected by these financial reforms
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