The Impact of Exchange Rate on Consumer Price Index in Malaysia: an Empirical Analysis (1970–2024)

Yam, Yi Wen (2026) The Impact of Exchange Rate on Consumer Price Index in Malaysia: an Empirical Analysis (1970–2024). Final Year Project (Bachelor), Tunku Abdul Rahman University of Management and Tech.

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Abstract

Malaysia’s high dependence on international trade makes its economy particularly sensitive to exchange rate movements, as a large share of food, raw materials, and fuel is imported. This vulnerability underscores the importance of examining how exchange rate fluctuations influence domestic inflation. Against this backdrop, this study employs the Vector Autoregressive (VAR) model and the Vector Error Correction Model (VECM) to examine the short-run dynamics and long-run equilibrium relationship between the exchange rate, lending interest rate, and the Consumer Price Index (CPI) in Malaysia over the period 1970 to 2024, as well as the speed of adjustment back to equilibrium. To ensure robustness, stationarity tests, cointegration analysis, and a series of diagnostic checks were conducted. The results reveal a significant positive relationship between the exchange rate and CPI, indicating that depreciation of the Ringgit contributes to higher inflation. Lending interest rates also affect CPI, though the relationship is weaker and negative. Furthermore, the findings suggest that inflation adjusts only slowly back to its long-run equilibrium following short-run shocks, likely due to price stickiness, weak monetary transmission, and delayed inflation expectations. These findings provide valuable insights for policymakers, consumers, and businesses. Policy recommendations include macroeconomic measures to enhance exchange rate stability and strengthen monetary transmission, alongside micro-level strategies such as financial literacy programs and the promotion of currency-hedging practices to help households and firms better manage the effects of exchange rate volatility.