OPTIMAL MONETARY POLICY AND THE EXTERNAL VARIABLES: EVIDENCE FROM ASEAN-3
Keywords:
Grid search, Optimal monetary policyAbstract
The aim of this paper is to determine the optimal monetary policy rule for small open economies. The rationale behind is that the monetary policy is concerned not only in the output gap and the inflation, but also in the external variables constituting the ground for the analysis. The method is based on Svensson (2000). Further, the paper intends to Explore the value of the loss function of the central bank. Using data from ASEAN-3, namely Indonesia, Malaysia and Thailand, the empirical results indicate that (1) the countries do care about the inflation and the output gap. This finding is in accordance with the central banks’ objective that price stability is the most important objective
of the monetary policy, (2) the exchange rates and terms of trade have impact on the central banks action (3) the specified instrument policy rule have to be considered as optimal in general. Indonesia and Thailand have comparatively smaller value of loss than Malaysia, which could be explained by the central banks of Indonesia and
Thailand have been introduced the inflation targeting in 2000, except for Malaysia.
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References
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Ball, L. (1999) Policy rules for open economies, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 127-144.
Baxter, M. and Kouparitsas, M. (2000) What causes fluctuations in the terms of trade?, NBER Working Paper 7462.
Bofinger, P. and Wollmershauser, T. (2003) Managed floating as a monetary policy strategy, Economics of Planning, 36, 81-109.
Broda, C. (2004) Terms of trade and exchange rate regimes in developing countries, Journal of International Economics, 63, 31-58.
Broda, C. and Tille, C. (2003) Coping with the terms-of-trade shocks in developing countries, Current Issues in Economics and Finance, Federal Reserve Bank of San Francisco, 9, 1-7.
Clarida, R., Gali, J. and Gertler, M. (1998) Monetary policy rules in practice: Some international evidence, European Economic Review, 42, 1033-1067.
Edwards, S. (1989) Temporary terms of trade disturbances, the real exchange rate and the current account, Economica, 56, 343-357.
Edwards, S. (2006) The relationship between exchange rates and inflation targeting revisited, NBER Working Paper 12163.
Fane, G. (2005) Post-crisis monetary and exchange rate policies in Indonesia, Malaysia and Thailand, Bulletin of Indonesian Economic Studies, 41, 175-195.
Funke, N., Granziera, E. and Iman, P. (2008) Terms of trade shocks and economic recovery, IMF Working Paper WP/08/36.
Gali, J. and Gertler, M. (1999) Inflation dynamic: A structural econometric approach, Journal of Monetary Economics, 44, 195-222.
Greene, W. H. (2000) Econometric Analysis, 5th edn, Prentice-Hall, Upper Saddle, NJ.
Gruen, D. and Dwyer, J. (2008) Are terms of trade rises inflationary?, Australian Economic Review, 29, 211-224.
Guender, A. V. (2005) On optimal monetary policy rules and the role of MCIs in the open economy, Open Economies Review, 16, 189-207.
Hataiseree, R. and Rattanalungkarn, T. (1998) Strategies for Thailand’s monetary policy operations in the year 2000: Inflation targeting versus monetary targeting?, Bank of Thailand Monthly Bulletin, 38, 11-42.
Ito, T. and Hayashi, T. (2004) Inflation targeting in Asia, Occasional Paper No. 1, Hong Kong Institute for Monetary Research, Hong Kong.
Jaaskela, J. P. (2005) Inflation, price level and hybrid rules under inflation uncertainty, Scandinavian Journal of Economics, 107, 141-156.
Jondeau, E. and Le Bihan, H. (2000) Evaluating monetary policy rules in estimated forwardlooking models: A comparison of US and German monetary policies, Notes d’Etudes et de recherché, Banque de France, 76.
Levieuge, G. (2008) Implementing the Svensson’s approach to determine simple optimal monetary policy rules with ESTIMA RATS, Laboratoire d’Economies D’Orleans, Collection Lecture & Methodologie No. 2008-01.
Levin, A. T. and Williams, J. C. (2003) Robust monetary policy with competing reference models, Journal of Monetary Economics, 50, 945-947.
McCauley, R. N. (2006) Understanding monetary policy in Malaysia and Thailand: objectives, instruments and independence, BIS Papers, 31, 172-196.
Mckinnon, R. (2003) The world Dollar standard and globalization, new rules for the game, Stanford University, August.
Newey, W. and West, K. (1994) Automatic lag selection in covariance matrix estimation, Review of Economic Studies, 61, 631-653.
Rudebusch, G. D. and Svensson, L. E. O. (1999) Policy rules for inflation targeting, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 203-263.
Pei-Tha, G and Kian-Teng, K. (2008) Estimating monetary policy rules: An optimal monetary conditions index for Malaysia, International Research Journal of Finance and Economics, 14, 196-211.
Pei-Tha, G. and Yu, H. (2009) Optimal Islamic monetary policy rule for Malaysia: the Svensson’s approach, International Research Journal of Finance and Economics, 30, 165-176.
Smets, F. (2002) Output gap uncertainty: does it matter for the Taylor Rule?, Empirical Economics, 27, 113-129.
Smets, F. (2003) Maintaining price stability: How long is the medium term?, Journal of Monetary Economics, 50, 1293-1309.
Smets, J. and Wouters, R. (2003) An estimated dynamic stochastic general equilibrium model of the Euro area, Journal of the European Economic Association, 1, 1123-1175.
Svensson, L. (2000) Open-economy inflation targeting, Journal of International Economics, 50, 155-183.
Taylor, J. B. (1993) Discretion versus policy rules in practical guide, Carnegie-Rochester Conference Series on Public Policy, 39, 195-214.
Taylor, J. B. (1999) A history analysis of monetary policy rules, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 319-341.
Todaro, M.P. (2000) Economic Development, 7th edn, Addison-Wesley.
Woodford, M. (2003) Optimal monetary policy inertia, Review of Economic Studies, 70, 861-886.
Ball, L. (1999) Policy rules for open economies, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 127-144.
Baxter, M. and Kouparitsas, M. (2000) What causes fluctuations in the terms of trade?, NBER Working Paper 7462.
Bofinger, P. and Wollmershauser, T. (2003) Managed floating as a monetary policy strategy, Economics of Planning, 36, 81-109.
Broda, C. (2004) Terms of trade and exchange rate regimes in developing countries, Journal of International Economics, 63, 31-58.
Broda, C. and Tille, C. (2003) Coping with the terms-of-trade shocks in developing countries, Current Issues in Economics and Finance, Federal Reserve Bank of San Francisco, 9, 1-7.
Clarida, R., Gali, J. and Gertler, M. (1998) Monetary policy rules in practice: Some international evidence, European Economic Review, 42, 1033-1067.
Edwards, S. (1989) Temporary terms of trade disturbances, the real exchange rate and the current account, Economica, 56, 343-357.
Edwards, S. (2006) The relationship between exchange rates and inflation targeting revisited, NBER Working Paper 12163.
Fane, G. (2005) Post-crisis monetary and exchange rate policies in Indonesia, Malaysia and Thailand, Bulletin of Indonesian Economic Studies, 41, 175-195.
Funke, N., Granziera, E. and Iman, P. (2008) Terms of trade shocks and economic recovery, IMF Working Paper WP/08/36.
Gali, J. and Gertler, M. (1999) Inflation dynamic: A structural econometric approach, Journal of Monetary Economics, 44, 195-222.
Greene, W. H. (2000) Econometric Analysis, 5th edn, Prentice-Hall, Upper Saddle, NJ.
Gruen, D. and Dwyer, J. (2008) Are terms of trade rises inflationary?, Australian Economic Review, 29, 211-224.
Guender, A. V. (2005) On optimal monetary policy rules and the role of MCIs in the open economy, Open Economies Review, 16, 189-207.
Hataiseree, R. and Rattanalungkarn, T. (1998) Strategies for Thailand’s monetary policy operations in the year 2000: Inflation targeting versus monetary targeting?, Bank of Thailand Monthly Bulletin, 38, 11-42.
Ito, T. and Hayashi, T. (2004) Inflation targeting in Asia, Occasional Paper No. 1, Hong Kong Institute for Monetary Research, Hong Kong.
Jaaskela, J. P. (2005) Inflation, price level and hybrid rules under inflation uncertainty, Scandinavian Journal of Economics, 107, 141-156.
Jondeau, E. and Le Bihan, H. (2000) Evaluating monetary policy rules in estimated forwardlooking models: A comparison of US and German monetary policies, Notes d’Etudes et de recherché, Banque de France, 76.
Levieuge, G. (2008) Implementing the Svensson’s approach to determine simple optimal monetary policy rules with ESTIMA RATS, Laboratoire d’Economies D’Orleans, Collection Lecture & Methodologie No. 2008-01.
Levin, A. T. and Williams, J. C. (2003) Robust monetary policy with competing reference models, Journal of Monetary Economics, 50, 945-947.
McCauley, R. N. (2006) Understanding monetary policy in Malaysia and Thailand: objectives, instruments and independence, BIS Papers, 31, 172-196.
Mckinnon, R. (2003) The world Dollar standard and globalization, new rules for the game, Stanford University, August.
Newey, W. and West, K. (1994) Automatic lag selection in covariance matrix estimation, Review of Economic Studies, 61, 631-653.
Rudebusch, G. D. and Svensson, L. E. O. (1999) Policy rules for inflation targeting, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 203-263.
Pei-Tha, G and Kian-Teng, K. (2008) Estimating monetary policy rules: An optimal monetary conditions index for Malaysia, International Research Journal of Finance and Economics, 14, 196-211.
Pei-Tha, G. and Yu, H. (2009) Optimal Islamic monetary policy rule for Malaysia: the Svensson’s approach, International Research Journal of Finance and Economics, 30, 165-176.
Smets, F. (2002) Output gap uncertainty: does it matter for the Taylor Rule?, Empirical Economics, 27, 113-129.
Smets, F. (2003) Maintaining price stability: How long is the medium term?, Journal of Monetary Economics, 50, 1293-1309.
Smets, J. and Wouters, R. (2003) An estimated dynamic stochastic general equilibrium model of the Euro area, Journal of the European Economic Association, 1, 1123-1175.
Svensson, L. (2000) Open-economy inflation targeting, Journal of International Economics, 50, 155-183.
Taylor, J. B. (1993) Discretion versus policy rules in practical guide, Carnegie-Rochester Conference Series on Public Policy, 39, 195-214.
Taylor, J. B. (1999) A history analysis of monetary policy rules, in Monetary Policy Rules (Ed.) J. B. Taylor, University of Chicago Press, Chicago, pp. 319-341.
Todaro, M.P. (2000) Economic Development, 7th edn, Addison-Wesley.
Woodford, M. (2003) Optimal monetary policy inertia, Review of Economic Studies, 70, 861-886.
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Published
2012-10-03
How to Cite
Gan, P.-T., Mohd Hussin, M. Y., & Muhammad, F. (2012). OPTIMAL MONETARY POLICY AND THE EXTERNAL VARIABLES: EVIDENCE FROM ASEAN-3. Journal of Contemporary Issues and Thought, 2, 1–16. Retrieved from https://ojs.upsi.edu.my/index.php/JCIT/article/view/916
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