Short run dynamics of selected macroeconomic variables in Malaysia : a vector autoregression approach

Abstract

Macroeconomic stability is an important input for economic development as it provides an essential framework for markets to perform efficiently. The macro environment in Malaysia is relatively stable, but the exact economic process underlying this stability remains an enigma. This study explores the short run dynamics of output, money supply, price level, interest rates and exchange rates for the Malaysian economy during 1979 to 1994 within a Vector AutoRegression framework. This understanding of the dynamics may be used to aid policy formulation, and also to explore the nature of Malaysian markets and institutions. The dynamic behaviour of the variables are examined through impulse response functions and forecast error variance decompositions. Two orderings, in broad Keynesian and Monetarist traditions, were used. It was found that both orderings exhibit similar qualitative properties. The findings suggest that output's response to its own shock is remarkably short-lived while interest rate and exchange rate each contribute a significant proportion of output's forecast error. For the price level, its own shock remains the most important contributor even after three years. The influence from the CPI to money supply is strong, while the reverse influence is weak.