The relationship between financial development and effectiveness of monetary policy: new evidence from ASEAN-3 countries

This paper aims to investigate the relationship between financial development (FD) and monetary policy effectiveness (MPE) on output and inflation in ASEAN-3 countries (Singapore, Malaysia and the Philippines).

This study uses an open economy structural vector autoregressive model to generate MPE. Then, an autoregressive distributed lagged (ARDL) model is used to analyze the effect of FD on MPE across countries.

The findings revealed that FD plays a different role in MPE across countries. In Malaysia, a more developed financial system tends to reduce the MPE on output, whereas in Singapore, results show that the more developed financial system (stock market capitalization) tends to increase MPE on output. However, in the Philippines, the main results show that the effect of FD (liquid liabilities) upon MPE on output is depending on the policy variable (interest rates or money supply).

This paper fills this gap by providing the first study of ASEAN-3 countries in examining how effective is a monetary policy in response to the development of the financial market across the country. Second, this paper considers two FD indicators, namely, the banking sector and capital market development in investigating its effect on MPE on output and inflation. Third, the authors construct the MPE in each country using a structural (identified) VAR model by aggregating the response of output growth and inflation rate on monetary policy changes (interest rate and money supply) using impulse–response function. Regarding this, the results of this study provide new empirical evidence and insight into the long debate on the relationship between FD and the MPE.