Capital Flows and Monetary Policy: Evidence from Pre-Crises ASEAN Economies

Indonesia, Malaysia, Philippines and Thailand had open financial markets and pegged exchange rates over the period leading up to their financial crises in the 1990s. This chapter examines the extent of their domestic monetary autonomy: using a variant of the monetary model of the balance of payments, it investigates the extent to which domestic monetary policy is frustrated by capital inflows. To do so, it estimates for each country the ‘offset coefficient’ — a summary measure of the degree to which the induced capital flows offset domestic monetary policy. Next, a monetary policy reaction function is estimated for each country to determine the extent to which monetary authorities pursued sterilization measures to counter capital flows. It then examines the degree to which central banks in these countries employed monetary policy for domestic goals by estimating an interest rate equation to assess the effectiveness of sterilization measures. The empirical results show that the capital flow offset was less than complete and sterilization attempts by central banks turned out to be ineffective in three of the four countries.