¶ … Monetary and Fiscal Policies in Malaysia Malaysia is a small, trade-dependent economy with a high amount of foreign presence in both the real and financial sectors; globalization and capital flows have therefore had a considerable impact on the operation of monetary policy in the nation. Over the last decade, Malaysia has had quite a diverse experience in its monetary policy operations, with the alterations in the monetary framework being made mostly in response to global developments (Cheong, n.d.).

During the 1970s, the Malaysian government played a key function in the economy. The government ventured beyond its customary functions and took on a more direct and active role in the nation's overall social and economic development process. This era saw the government's direct contribution in the private sector through the founding of large commercial enterprises. Government contribution in the economy expanded further in 1980-82 as it pursued an expansionary countercyclical fiscal policy designed at stimulating economic action and supporting growth to ride out the effects of the global recession. The countercyclical policy led to double deficits in the government's fiscal position and the equilibrium of payments. When confronted with this double deficit problem, the government put into practice widespread structural programs to decrease spending and rearranged national objectives consistent with domestic resource accessibility and to make sure carefulness in its recourse to external borrowing (Vijayaledchumy, n.d.).

The development of the monetary policy framework can be roughly characterized by the following developments:

The move in monetary policy strategy from monetary targeting towards interest rate targeting in the mid-1990s

The in-between changes in introducing more market-based monetary policy implementation procedures since the crisis.

Prior to the mid-1990s, the monetary policy strategy had been founded on targeting monetary aggregates. This was an inside strategy and was not officially announced to the public. The employment of this strategy was founded on evidence that the monetary aggregates were closely connected to the final objectives of monetary policy....

Given that price stability was the eventual objective of monetary policy, monetary targeting was seen as an appropriate target for policy. Throughout this period, the central bank, Bank Negara Malaysia (BNM) influenced the daily volume of liquidity in the money market, consistent with the monetary growth target. This was to make sure that the supply of liquidity was adequate to meet the demands of the economy, in line with the Bank's monetary policy objective of price stability. Yet, subsequent developments in the economy and financial system throughout the early 1990s weakened this association and highlighted the problems connected with using monetary aggregates as policy targets. "In particular, the globalization of financial markets had altered the money demand function, making the relationship between monetary aggregates and output as well as prices less stable. The large capital inflows in 1992-93, followed by a reversal in the following year, brought to the forefront the instability of monetary aggregates as targets" (Cheong, n.d.).
With the fall of Lehman Brothers in September 2008, the supplementary global liquidity squeeze greatly affected Malaysia. U.S. dollar funding pressures resulted in sharply wider cross currency basis swap spreads and irregular evidence of difficulty in accessing credit. Intervention and some depreciation of the exchange rate, as a reply to capital outflow pressures. "BNM cut policy interest rates by 150 basis points to 2%, and reduced reserve requirements to ease financial intermediation costs. In addition to other financial policy measures, two fiscal stimulus packages were implemented to cushion the economy. The swift and comprehensive policy response, against the backdrop of robust financial and corporate sector balance sheets, helped cushion the downturn. Despite the very severe shock to the economy, output contracted relatively modestly before rebounding rapidly in 2010" (Alp, Elekdag, & Lall, 2012).

A strong commitment to fiscal sustainability was critical for macroeconomic stability as well as to make sure sustainable long-term growth. Malaysia continued to enjoy flexibility in growing its fiscal position, which remains sustainable given the government's fiscal carefulness…