By Dr Paul Anthony Mariadas and Dr Uma Murthy
Inflation is an economic phenomenon characterised by a general increase in the prices of goods and services in an economy over a period of time. Bank Negara Malaysia (BNM) has the mandate to control inflation by setting and adjusting the Overnight Policy Rate (OPR) as part of its monetary policy tools. However, despite the best efforts of BNM to control inflation, it can still persist. There are several reasons why inflation cannot always be controlled by BNM through OPR adjustments.
Firstly, inflation can be caused by factors outside of BNM’s control. For instance, global oil prices, which Malaysia depends on, can be volatile and subject to geopolitical factors, which may drive up the cost of living for Malaysians. Natural disasters, such as floods, can also disrupt the supply chain of goods and services, leading to inflationary pressures.
In these instances, adjusting the OPR may not have a significant impact on controlling inflation. Malaysia is a net importer of oil, which means that global oil prices can have a significant impact on inflation in the country. For example, in 2018, global oil prices increased significantly, which led to a rise in Malaysia’s inflation rate from 1.8% in January 2018 to 3.7% in June 2018. During this period, BNM increased the OPR twice, by a total of 25 basis points, but the inflation rate remained above the target range of 2-3%.
In addition, in 2014, Malaysia experienced severe flooding, which disrupted the supply chain of goods and services, leading to a rise in food prices. This contributed to an increase in Malaysia’s inflation rate from 2.7% in December 2014 to 3.5% in January 2015, despite BNM increasing the OPR to 3.25% in July 2014.
Secondly, the effectiveness of monetary policy tools such as OPR adjustments may be limited in controlling inflation, particularly if there are structural issues in the economy. For example, if there are supply-side constraints, such as a shortage of skilled labour or limited production capacity, adjusting the OPR may not increase the supply of goods and services, and hence, may not lower prices.
Additionally, if inflation is driven by excessive government spending or fiscal deficits, monetary policy tools alone may not be sufficient to control inflation. One structural issue in the Malaysian economy is a shortage of skilled labour, which can limit production capacity and lead to supply-side inflation. In 2017, Malaysia’s inflation rate rose from 3.2% in January to 5.1% in March due to a shortage of workers in the construction and manufacturing sectors.
Thirdly, there can be lags in the transmission of monetary policy. It may take time for changes in the OPR to be reflected in lending rates and consumer spending behaviour, and hence, may not have an immediate impact on inflation. Furthermore, changes in the OPR may not affect all sectors of the economy equally, and some sectors may be more sensitive to interest rate changes than others.
Another limitation of monetary policy tools is their effectiveness in controlling inflation driven by excessive government spending or fiscal deficits. In 2020, Malaysia’s inflation rate increased from 1.3% in January to 2.7% in February due to higher food prices and the reintroduction of the Sales and Services Tax (SST). However, BNM faced limitations in using monetary policy tools to control inflation as the government announced stimulus packages to support the economy during the COVID-19 pandemic, which led to a wider fiscal deficit.
Next, in 2019, BNM decreased the OPR by a total of 25 basis points to stimulate economic growth. However, the impact on inflation was not immediate, and the inflation rate continued to increase from 0.2% in January to 0.4% in May. It was only in the second half of 2019 that the inflation rate began to moderate due to lower food and fuel prices.
Lastly, inflation expectations can be self-fulfilling. If consumers and businesses expect prices to continue rising, they may adjust their behaviour by purchasing goods and services before prices increase further, leading to higher demand and higher prices. In this case, monetary policy tools such as OPR adjustments may not be effective in controlling inflation. In 2017, Malaysia’s inflation rate increased from 3.2% in January to 5.1% in March, partly due to rising inflation expectations among consumers and businesses. This led to higher demand for goods and services, which contributed to higher prices.
In conclusion, while BNM has the mandate to control inflation, there are external factors, structural issues, limitations of monetary policy tools, lags in transmission, and inflation expectations that can all contribute to persistent inflation. Therefore, effectively controlling inflation requires a multi-faceted approach, including both monetary and fiscal policy tools, addressing structural issues in the economy, and managing inflation expectations.
Dr Paul Anthony Mariadas and Dr Uma Murthy are Lecturers for the School of Accounting and Finance at Taylor’s Business School, Faculty of Business and Law, Taylor’s University. Taylor’s Business School is the leading private business school in Southeast Asia for Business and Management Studies based on the 2023 QS World University Rankings by Subject.
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