P -Star, Exchange Rate Regime and Inflation Determination: The Malaysian case

Michael Meow-Chung Yap

Journal of the Asia Pacific Economy, 2002, vol. 7, issue 3, 379-407

Abstract: Introduced in 1989, the P -star model draws on the quantity theory of money. Money plays a central role in determining the long-termprice level. The model has been applied to various industrialized countries. Its advantage is in providing a consistent framework for analysing short-term monetary policy setting against the prospects of achieving a longer-term price stability objective. Hence its adoption greatly assists policy-makers in overcoming the 'time-inconsistency' problem by taking a forward-looking approach to policy. This article analyses the relevance of the P -star model to the Malaysian experience. An extension to the original P -star model, following a generalized monetary approach to the balance of payments and which allows the evaluation of the exchange rate regime's influence on inflation, is also tested. It is found that the original P -star model fits the Malaysian case well although the extended model cannot be rejected. The results strongly support the view that inflation in Malaysia is largely determined by domestic disequilibria although the role of the exchange rate regime cannot be ignored. The analysis provides firm support for using the monetary aggregates in a central role in conducting monetary policy. It strongly advocates the P -star approach as a guidepost to monetary policy.

Date: 2002
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DOI: 10.1080/1354786022000007898

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