EFFECTIVE monetary policy is not just about raising or lowering interest rates by the right amount at the right time, but rather about effectively communicating the reasons for interest rate changes.
Credible, accountable, and transparent policy announcements help people feel reassured that policy changes are properly justified.
Yesterday, Bank Negara Malaysia (BNM) made very clear its decision to raise the overnight interest rate (OPR) by 0.25% for the second time in two months.
In a spirit of greater transparency, the release of the monetary policy statement was followed by an open and detailed briefing for economists and analysts, which clarified many issues of concern.
First, we learned that BNM is more confident about Malaysia’s recovery based on indicators such as employment, wages and opening up of key sectors including tourism.
The broad base of the recovery and the oncoming impact of say EPF withdrawals also contribute to their view that the recovery is and will be more robust.
Hence, it sticks to the positive forecasts for growth in the range of 5.3% to 6.3%.
External headwinds, including the impact of rising international and local cost pressures, the military conflict in Ukraine and tight containment measures in China, are also realistic, posing risks but not fundamentally reducing its baseline guidance.
Second, we have learned that BNM is not targeting inflation with these rate hikes, but is taking a more holistic view, consistent with its broader mandate.
Inflation forecasts are kept at 2.2-3.2% for headline inflation and 2-3% for core inflation, leaving no particular or new inflation concerns to target with higher interest rates.
In particular, according to BNM’s analysis, higher consumer and business demand due to excess supply capacity will not cause demand-pull inflation.
When demand increases, the supply gap is filled without a price increase. While the prices of some items may remain high, we won’t see them rising as much in the future.
We also learned that BNM stands by its long-held position that rate changes are not caused by “following the Fed” or “chasing the exchange rate.”
BNM confirmed that it has no exchange rate target and cannot systematically influence the level of the exchange rate.
At best, it can dampen short-term volatility, but they cannot use interest rates and exchange rates to influence domestic inflation, for example. That is clear and correct.
Third, the main argument for raising the OPR is to recalibrate interest rates across the economy.
With a more robust recovery, it is calculated that we no longer need the low interest rates that were necessary during the recent crisis and that the economy can now afford higher interest rates without jeopardizing growth. In a way, this is a vote of confidence in its growth forecasts.
This “normalization thesis” is common to many central banks around the world, but higher interest rates increase the cost of funding for adjustable rate loans, which represent the largest number of loans and the main type of loans held by the B40 group.
BNM calculates that the impact of the two recent rate hikes will add RM80 per month to the cost of a RM300,000 mortgage, which it considers affordable as incomes, jobs and economic activity improve.
So we’re clearer on the rationale behind the rate hikes, but now the big question is: when will we hit the ‘normal’ or ‘recalibrated’ rate?
Or to put it another way: When will interest rate hikes stop?
BNM has an honest answer to these questions, which is that there is no specific target public interest rate and that the Monetary Policy Committee (MPC) decision-making process is holistic, aiming at collegial consensus rather than majority voting as in other central banks.
The question of the “normal” interest rate therefore remains open.
The BNM also acknowledged that there are some signs of structural change in the economy, particularly in the service sector, in digitization and e-commerce, and in the labor market.
This means that the correct interest rate in the past may not be the correct interest rate in the future.
We have also long argued that the impact of the Covid-19 lockdowns has caused a structural disruption in the Malaysian economy that requires further research and analysis to understand.
This is crucial as we need to know if past ideas and models are useful for future policy decisions.
More broadly, we also need to understand the new drivers of economic growth and the things that will help the economy fare better in the future.
This is broader than the BNM’s monetary policy remit, but it is a key area of research that we need to focus on now. – July 7, 2022.
* Professors Paolo Casadio and Geoffrey Williams are economists.
* This is the opinion of the author or publication and does not necessarily represent the views of The Malaysian Insight. The article may be edited for brevity and clarity.