Fisher Effect in Malaysia: Evidence from Malaysian Government Securities (MGS) Yields Using ARDL

Abdul Salim, Nur Alysha' (2025) Fisher Effect in Malaysia: Evidence from Malaysian Government Securities (MGS) Yields Using ARDL. Final Year Project (Bachelor), Tunku Abdul Rahman University of Management and Technology.

Text 202405_BBBE3053_NUR ALYSHA (FULL FYP).pdf Restricted to Registered users only Download (2MB)

Abstract

This paper investigates the relationship between inflation and nominal interest rates to determine the presence of the Fisher Effect (FE) in Malaysia. Using monthly inflation data and yields from 3-year Malaysian Government Securities (MGS1) as a proxy for nominal interest rates from 2007 to 2023, the study employs the Autoregressive Distributed Lag (ARDL) approach to analyse both the existence and magnitude of the long- and short-run relationships between these variables. The empirical analysis reveals no long-run cointegrating relationship between inflation and MGS1 yields, indicating that inflationary shocks do not exert enduring effects on bond yields. A strong autoregressive component was identified in MGS1 yields, as evidenced by a lagged dependent variable coefficient of 0.921783, signifying substantial persistence in yields. Current inflation exerts a positive influence on nominal interest rates, supporting the existence of the FE. However, this response remains partial, suggesting inefficiencies in the financial market's ability to adjust to inflationary pressures. At the same time, the negative coefficient for lagged inflation indicates a diminishing impact over time, highlighting a stabilisation process following initial inflationary shocks. These findings align with existing literature that documents weak forms of the FE in developing economies, characterized by financial market inefficiencies and economic volatility. The study has important policy implications, supporting Bank Negara Malaysia's (BNM) adoption of adaptive and flexible monetary policies. BNM should leverage a mix of macroprudential tools, financial market reforms, and market interventions in response to shocks and crises, alongside adjusting the policy rate. Coordinated fiscal and monetary responses are also crucial for addressing both demandand supply-side inflationary pressures. Proactive monetary policy interventions by BNM can effectively moderate the immediate impacts of inflationary pressures on nominal interest rates while fostering economic growth through a stable interest rate trajectory. The study does have limitations that warrant consideration in future research. Employing a Nonlinear Autoregressive Distributed Lag (NARDL) model could provide insights into the asymmetric effects of inflation shocks on bond yields, a dimension not captured by the linear ARDL approach. In addition, the narrow focus on MGS1 as a proxy for interest rates advocates for the inclusion of other financial instruments and bond maturities in future studies. Lastly, the limited time frame of the analysis, which does not encompass the Asian Financial Crisis, potentially overlooks critical dynamics during periods of financial stress.