Exchange rate behaviour and management in Malaysia: empirical study across regimes

Given the heightened volatility in the financial market due to global economic developments, a study on exchange rate behaviour becomes crucial for the economic stability and achievement of macroeconomic objectives. There have been claims that fixed exchange rate regime is more prone to overvaluation and responsible for devastating currency crises. However, empirical studies on exchange rate behaviour do not seem to have established whether currency misalignment and the regime choice are the ones potentially responsible. This study thus examines the behaviour of exchange rates and its management given the unique experience in Malaysia during the 1997 financial crisis. Firstly, its objective is to measure real exchange rate misalignment (RERMIS) upon estimation of its equilibrium level. Secondly, this study tests the Fixed Exchange Rate Regime-Misalignment (FERRM) hypothesis in establishing whether the pegged regime contributed to the worsening of misalignment. The third objective looks into the exchange market pressure (EMP) and its associated intervention. It answers the question of “deliberateness” with regard to exchange rate management policy, specifically whether it is a resulting behaviour of deliberate action or merely due to the market forces. The fourth brings in the lead-lag relationship between Thailand and Malaysia to revisit the contagion issue based on a more advanced methodology, the wavelet. The first part that addresses the first two objectives employs the ARDL-UECM and Pesaran’s Bounds test. A model of the long run equilibrium real exchange rate (ERER) based upon macroeconomic fundamentals is employed to calculate RERMIS. It calculates the ERER and examines whether the real exchange rate departs from its estimated equilibrium. The second part addressing the third objective employs an EMP methodology advocated by Eichengreen, Rose and Wyplosz, and Jeisman. EMP and the degree of intervention (DI) indices are computed with the objective to assess the presence of intervention. Finally, the third part addressing the fourth objective applies wavelet tools to examine the presence of contagion and its associated duration.