Divisia Index Monetary Aggregates: Do they Matter for Monetary Policy in Malaysia?
DOI:
https://doi.org/10.32890/mmj2004.8.1.3Keywords:
Divisia, simple-sum, monetary aggregates, unit root, ECM, root mean square error, root mean absolute error, root mean absolute percentage errorAbstract
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The theoretical advantage of the Divisia index has now taken the forefront in many monetary analyses. Many central banks of the developed economies have developed database on Divisia indices for monetary aggregates. Nevertheless, the Central Bank of Malaysia (BNM) does not use a Divisia index. Formulating of monetary policy by the central bank of Malaysia is still reliant on the traditional simple-sum method of monetary aggregation. In this study we investigated empirically the various measures of monetary aggregates namely, the Divisia M1, simple-sum M1, Divisia M2 and simple-sum M2. Unlike the narrowly defined monetary aggregate, the method of aggregation for broader defined monetary aggregate M2 does show significant differences in both level and growth rates, thereby suggesting the importance of measuring monetary aggregates appropriately. Anderson, R. G., Jones, B. E, & Nesmith, T. D. (Jan-Feb,1997). Building new monetary services indexes: concept, data, and methods. Federal Reserve Bank of St. Louis Review. 53-82. We ascertained that there exists long-run relationship between all measures of monetary aggregates in this study with inflation. By constructing the dynamic error-correction models for the alternative measures of monetary aggregates, we performed out-of sample forecasting for three different periods and compared the forecasting ability of Divisia monetary aggregates namely Divisia M1 and M2, with their simple-sum counterparts that is, M1 and M2. Analysis of the forecasting statistics indicates that the Divisia monetary aggregates performed better than their simple-sum counterparts in forecasting ability. However,
Habibullah (1998) used the P-Star model approach in determining inflation in Malaysia. Contrary to our results, he concludes that the Divisia index (Malaysia’s monetary data) does not support the P-Star approach in modeling inflation. In reference to the objective of the Central Bank of Malaysia to maintain price stability, we thus conclude that the Divisia monetary aggregates, particularly the Divisia M2, is a viable candidate for target or indicator in formulating the monetary policy in Malaysia.
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