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Money demand, bank credit and real exchange rates in a small open developing economy : an econometric analysis for Malaysia
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Tan, Eu Chye (1995) Money demand, bank credit and real exchange rates in a small open developing economy : an econometric analysis for Malaysia. PhD thesis, University of Warwick.
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Official URL: http://webcat.warwick.ac.uk/record=b1399529~S1
Abstract
This is essentially a three-part thesis on money demand, bank credit and real exchange rates in
Malaysia. Long and short run real money demand functions with money variously defined as
MO, M1 and M2 have been estimated using the Johansen cointegration technique and the error
correction approach respectively. While liberalisation and innovation in the Malaysian financial
system have not ruled out the existence of stable long run money demand relationships as
attested to by the presence of cointegrating vectors, they have rendered short run relationships
unstable. This called for a reestimation of short run dynamics over more recent periods and all
the revised estimates could withstand a battery of diagnostic tests akin to original full sample
estimates. The estimated short run functions appear to track the direction of actual changes in
the demand for money reasonably well.
The second part of the thesis is basically concerned with the possible practice of equilibrium
credit rationing (a la Stiglitz & Weiss, 1981 & 1983) amongst commercial banks in Malaysia
and the significance of commercial bank credit vis-a-vis other monetary variables in the
determination of economic activity in Malaysia. Two of the major implications of equilibrium
credit rationing are the irresponsiveness of lending rates to changes in the factors determining
loan demand and supply and the presence of a 'ceiling' on the lending rate. Via an application
of cointegration and error correction techniques, the lending rate is found to be insensitive to
determinants of loan demand while only nominally sensitive to loan supply determinants. This
is corroborated by an evidence derived from an application of Sims' VAR technique that
shows a lack of responsiveness of the lending rate to changes in the inter bank rate used as a
proxy for the cost of financial market funds.
With regard to the ceiling on the lending rate arising from equilibrium credit rationing, its
effect on the volume of deposits and hence loanable funds mobilised by banks and the interest
rate payable on them may depend on the interest elasticity of their flows. Two separate cases
can be considered namely the case of zero elasticity and the case of non zero elasticity. In the
former case, if it is against the banks' interests to impose a high lending rate owing to possible
adverse selection effects, banks may suppress the deposit rate instead. In the latter case
however, the higher is the interest elasticity of deposits, the greater will be the amount of
loanable funds derived and the interest rate paid on them. In our empirical analysis involving
the application of cointegration and error correction techniques, commercial bank deposits in
Malaysia are found to have a zero elasticity in the short run. Hence the extent of excess
demand arising from an any practice of equilibrium credit rationing may be relatively limited.
By applying the Sims' VAR technique, commercial bank credit has been found to exert a
greater influence than MI, M2 and the lending rate on the Malaysian GDP.
The final part of the thesis pertains to exchange rates. In an adaptation of Dornbusch's (1976)
model, it appears that any policy measure aimed at alleviating the asymmetric information
problem in the domestic banking system could lead to a depreciation in the long run
equilibrium exchange rate and a rise in the long run equilibrium price level. The impact effects
are a weaker domestic currency and a higher output level. However the magnitude of the long
run and impact effects would vary directly with the interest elasticity of money demand.
The cointegration and error correction techniques have also been relied upon for estimating
the long run equilibrium real effective and bilateral exchange rates of Malaysia and the short
run dynamics of these rates a la Edwards (1988a, 1988b & 1989). The estimates suggest that
there has been no sustained overvaluation or undervaluation of the Malaysian real exchange
rates. By implication then, the question of a real exchange rate misalignment does not arise
and that Malaysia's success in economic development so far has not been due to any deliberate
undervaluation policy. Moreover the analysis of causal relationships amongst real exchange
rate movements on one hand and exports and GDP on the other has highlighted no significant
relationships existing between them. Finally, the results from modelling the short run dynamics
of real effective exchange rates indicate that excess domestic credit could induce their
depreciation instead of an appreciation, contrary to popular belief.
Item Type: | Thesis (PhD) | ||||
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Subjects: | H Social Sciences > HC Economic History and Conditions | ||||
Library of Congress Subject Headings (LCSH): | Malaysia -- Economic conditions, Demand for money -- Malaysia -- Econometric models, Bank loans -- Malaysia -- Econometric models, Foreign exchange rates -- Malaysia -- Econometric models | ||||
Official Date: | March 1995 | ||||
Dates: |
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Institution: | University of Warwick | ||||
Theses Department: | Department of Economics | ||||
Thesis Type: | PhD | ||||
Publication Status: | Unpublished | ||||
Supervisor(s)/Advisor: | Roe, Alan, 1942- ; Leech, Dennis | ||||
Sponsors: | Universiti Malaya | ||||
Extent: | v, 327 leaves | ||||
Language: | eng |
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