Malaysian central bankers have become victims of a running joke lately: if you are divided between maintaining a low unemployment rate and containing inflation, pray and do nothing.
On Friday last week, Bank Negara made known its decision to maintain the Overnight Policy Rate at 3.5% even as the local real interest rate is negative.
The recently published monetary policy statement is too hilarious for me to read quietly. It reminds me of what US President Harry Truman once famously said: “Give me a one-handed economist… All my economists say, ‘On the one hand… on the other’.” For sure, Truman would not find a one-handed economist on Jalan Dato’ Onn either.
The statement opens with a pessimistic tone by making references to the wage-price spiral and persistent inflation. It is all doom and gloom but then Bank Negara vows to take the “appropriate monetary policy response” to “maintain medium-term price stability and ensure that the high inflation does not undermine the longer growth prospects of the Malaysian economy.”
After comforting the public that the bank is prepared to do whatever is necessary to fight inflation, the bank says “while both the risks to higher inflation and the risks to slower growth have increased, the immediate concern is to avoid a fundamental economic slowdown that would involve higher unemployment”.
The statement ends with “based on this assessment, the Monetary Policy Committee has decided to keep the Overnight Policy Rate unchanged at 3.50%.”
Smooth.
To be fair, however, the bank did indicate that projected slower economic growth is expected to keep inflation in check. The statement also seems to suggest, or at least I interpret it as such, that the inflation rate we are experiencing is likely only a one-time spike.
The fact that there are lags between wages and prices would discourage a wage-price spiral, further providing the case that this high rate of inflation is unsustainable. All those control mechanisms over prices, though lamentable, do a good job at delaying the catch-up game between wages and prices. In other words, it helps keep inflation tamer than what it could have been.
I think the possibility that this is a one-time hike in inflation is important in understanding why the bank did not increase the OPR last week.
Ben Benarke in a speech last year said: “”¦With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation but only to a change in relative prices.”
This is probably what is happening at the moment, fuelling the rationale for Bank Negara to maintain the OPR.
But how confident are we that this is merely a one-off hike?
Well, the 7.7% inflation rate is mainly due to the June 5 hike in local retail fuel prices. It is fair to assume, especially with all the control regimes the state has put in place, that if there is another hike in inflation rate, it would probably be caused by another hike in retail fuel prices.
Within that context, world crude oil prices at the moment have taken a dive and the fall is nothing less dramatic. From close to US$150 per barrel, a record even in real price, it now hovers below US$125 per barrel.
Now, the jury may still be out but the demand curve has to contract sooner or later as market participants adapt to a new reality which calls for less reliance on fossil fuel. Just as how the 1970s taught us about our amazing versatility in solving crises, there is little reason for us to embrace the Malthusian logic now and throw in the towel.
If indeed the demand curve has shifted, then Bank Negara has all the more reason to expect that the current high rate of inflation is temporary in nature despite the expressed concern about persistent inflation. And the bank did indicate how temporary is temporary in the statement: by mid-2009, we should be able to party on and laugh all this off.
Perhaps more importantly, the government has little reason to increase prices at the pump if prices stabilize at the current level. With current global crude oil prices being so favorable to the state’s coffers, there has been talk within the Barisan Nasional government about reducing local retail fuel prices.
Apart from politically undercutting the Pakatan Rakyat, reduction of prices has the potential to bring down the inflation rate without the need to raise interest rate, thus providing the bank some room to do something about the unemployment rate.
But damn, negative real interest rate!
A version of this article was first published in The Malaysian Insider.
8 replies on “[1736] Of temporary inflation could be a reason for unchanged rate”
Yes I am.
Are you familiar with Hayek’s theory (or rather, the Austrian view) on business cycles?
Well, I have to stress that this is not about Bernanke. Sure, his helicopter drop is not something to admire but his positive econ is valuable nonetheless. I.think we need to stress its important for us to different between positive and normative econ. Bernanke was doing positive econ.
Re; phillips curve, well, I doubt anybody believes in the original version anyway. When the curve is mentioned, it is typically refers to at least the augmented version.
I don’t have anything against fiat currency per se – I’m with you against investing the power to print money in the hands of a few.
Bernanke is destroying the American dollar – but not that his printing of money is being of much effect in ‘stimulating’ the economy since banks are now more prudent with extending loans.
I don’t subscribe to the Phillips curve (not the long term one, at least) – to claim that there’s a natural trade-off between inflation and unemployment is just… iffy. In a climate of high inflation, people are less likely to invest and take risks anyway given the associated uncertainty and volatility. Tame inflation first, then deal with supply-side issues.
I’m not disagreeing with you. (Though I only have problem with state-controlled fiat currency, not against fiat currency in particular. Fiat currency is a natural evolution of specie currency)
But what I’m doing here is trying to be descriptive, not prescriptive.
Bernanke is an idiot. A Volcker is what we need.
In a “hard money” world, the amount available for investment can only come from SAVINGS, which means one has to CUT BACK on consumer credit and consumer goods. The more money people save, the lower the interest rate. The more they spend on consumption, the HIGHER the interest rate.
However if the state can PRINT MONEY, this natural mechanism is short-circuited — the “low interest” sends false signals to market participants, both consumers and producers. Artificially LOWERING of interest rates causes people to act in CONTRADICTORY ways:
i) Interest is (artificially) low, therefore people save LESS, spend more and borrow (consumer credit) more
ii) Interest is (artificially) low, therefore firms borrow and INVEST more into capital goods, and things like EXPANDING the business — building more factories, outlets, buying out other businesses, acquiring assets… all because the can borrow CHEAP in a climate of artificially low interest rates.
So what happens is that you get FIGHT between the users of consumer credit, spending on consumer goods and the folks who are investing — all DEMAND MONEY for “opposite” purposes.
Oh yeah, you get your ‘low employment rate’ for the time being too.
So let’s spend as much as we want, borrow as much as we can!
Do we dare to expect a happy ending?