A Structural Modeling of International Parities between Malaysia and China in the Liberalisation Era

Abstract

Abstract: This paper constructs a system assessment of Purchasing Power (PPP) and Interest Rate Parity (IRP) conditions between Malaysia-China using the structural VARX modeling method over 1994: Jan to 2011: June. The findings uphold support for long run PPP and IRP, when exchange rate regime and structural breaks of the Asia crisis and subprime crisis are taken into account. Despite the direct imported inflation, exchange rate also plays a significant role in the price transmission mechanism. Though Malaysia maintains a relative monetary autonomy against China in the short run, the price channel will affect the extent of IRP conditions between the two nations. Lastly, the faster pace of adjustment towards price instead of interest rate equilibrium implies the non appearance of sequencing problem in market integration. In essence, our model contribution is as an early warning system for Malaysia's economic defense against global shocks.