Financial Liberalization and Money Demand in ASEAN Countries: Implications for Monetary Policy

Monetary developments in Indonesia, Malaysia, Singapore, and Thailand since the early 1980s have to be assessed in the context of substantial changes in their financial markets. The rapid growth and deepening of financial markets reflect not only sustained increases in per capita incomes, but also financial market reforms that have increased competition and foreign capital inflows. This paper examines the extent to which financial market development and liberalization in these countries since the 1980s have affected money demand and seeks to draw implications for the operation of monetary policy. A prerequisite for operating a policy framework centered around monetary targets is a stable and predictable demand for money. However, the empirical results suggest continuing instability in the interaction of money growth, economic activity, and inflation--especially in the ASEAN countries that have undergone extensive financial market reforms. These results indicate that money growth rates may, at times, be poor predictors of future inflation and output trends. This finding suggests that Policy decisions will need instead to be based on a wider set of monetary and real sector indicators of inflationary pressures. The feasibility of alternative policy frameworks, including nominal exchange rate targets and inflation targets, is discussed in the context of the increasing integration of financial markets and the substantial increase in foreign capital inflows. The benefits of a pegged exchange rate in terms of stability must be weighed against other considerations, including the challenges of managing capital inflows and other real shocks. The paper concludes with some observations on the merits of inflation targets. Experience with the operation of inflation targets in other countries suggests that policy credibility is aided by the transparency of decision making.