Tag: monetary policy

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Economics

[2554] Is the real interest rate too high?

Those whom keep a close eye on monetary policy will realize that the real interest rate at the moment is positive. My data suggests it is above 1% mark right now given how the Overnight Policy Rate is at 3% and inflation is hovering around 2% with core inflation being slightly lower than headline inflation.

Despite an abstraction and not directly observed like the everyday nominal interest rate, it is the real interest rate that is crucial in determining decision between consumption and saving/investment in most cases. This is not to say the nominal interest rate is not an abstraction. It still is but real interest rate is not immediately understood or observed by laypersons as nominal interest rate.

The reason I am bringing up the issue about real interest rate is that I think there is a worry of a slowdown in the domestic economy, especially with European and Chinese economies showing signs of stress. And I am always not keen of shoring up the economy with fiscal policy in the traditional way as long as monetary policy can do the jobs well. I also think that monetary policy has done an excellent job in the past few years amid serious unprecedented crisis despite Keynesian’s liquidity trap theory, which appears to be irrelevant: as market monetarists have successfully argued, the fixation on interest rate is overrated in zero-interest rate situation. Market monetarists, the successor to the monetarism of the 1970s, of course, argue more about monetary policy but let us leave that aside for now because I know they would not like my fixation with interest rate here.

With more than 1% real interest rate, this creates the incentive to save more than to spend in the economy. Or to invest less. The bottom line is that it has a negative impact on economic growth.

One also has to remember that the OPR is the base rate. There are other rates based on the OPR and they are priced higher. This means the relevant real interest rate are higher than 1% for consumers and businesses.

Furthermore, in the free (or rather, maybe, just efficient?) market, I would assume the optimal real interest rate is 0%. This suggests that even under free market environment, the real interest rate is too high.

There are other considerations in the settings of the rate. One big consideration is the management of inflation. But with demand-pull inflation coming down and with downside risk as far as growth is concerned, I think there is room to make the real interest rate more accommodative to economic growth without scaring the hawks away.

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Economics

[2496] Taylor’s OPR (more proof we did not need that stimulus)

Since the Monetary Policy Committee will be meeting next week, it is only natural to talk about the Overnight Policy Rate. It currently stands at 3.00% and it is likely to stay like that after the MPC meet. I personally (and professionally!) am betting a cut only in March as I think while inflationary pressure is receding, it is still high. Maybe, there is a bias in that expectation. What can I say?

But what would a customized Taylor’s rule say?

This particular Taylor’s rule is imperfect as the “equilibria” are somewhat squishy and not quite as methodical as I would like it to be, but in the coming weeks I should be able to calculate better coefficients to produce better hypothetical rate to compare with the actual OPR.

But observing the preliminary customized Taylor’s rule of mine, the OPR does seem to lag behind the rule. When I met some officials and economists from the Malaysian central bank a month or two back, they cheekily said they would not reveal the “natural rates”. The next time I meet them, I plan to cheekily share with them my Taylor’s rule, and say “you don’t have to tell me because I can read your mind.”

What I find interesting is that during the last recession, the Taylor’s rule suggests that Malaysia would have been in some kind of liquidity trap if the OPR had followed the rule closely. More interestingly, since the monetary policy was tight during that time, it could have been loosened more, leaving little if any need forĀ  the 2008/2009 fiscal stimulus. Yet another proof against the Najib administration’s fiscal stimulus (or non-stimulus as Mr. Hisham, I would imagine, would put it).

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Economics

[2400] Good news for the hawks

An argument goes that rate hike will not address inflationary pressure in Malaysia.

It is not as effective against cost-push inflation as it is against demand-pull inflation. And right now, theĀ economy is experiencing cost-push inflation. More importantly, the push is coming from abroad. It is practically exogenous, discounting the liberalization exercise (which itself originates from exogenous pressure applied on government finance).

Hike the rate and price increase will not slow down by much. Local demand is not big enough to slow down the advance of the prices powered mostly by the larger foreign demand.

So, there is little need to increase the rate.

If the mysterious author at Economics Malaysia is correct, then rate hike might be more effective than proponents of the cost-push narrative are willing to accept. The author believes that the economy is already running at its full capacity. He believes the unemployment rate basically is bottoming out and is unlikely to go down any further in a significant manner.[1]

I am will not go into the numbers but the logic is sound.

Because it is sounds, it suggests that demand-push inflation making its round, thus making the exogenous cost-push story line less weight in the determination of monetary policy.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1]Ā ā€” Iā€™d still take this as a signal that the economy is at full capacity, as weā€™re looking at near historical lows in the unemployment rate. While GDP growth likely softened in 2Q 2011, thereā€™s been little impact on jobs so far ā€” Juneā€™s numbers however may show a different story. [Hishamh.Ā May 2011 Employment Report: Softly, Softly. Economics Malaysia. July 25 2011]

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Economics

[2385] A case of MPs subverting the independence of the Bank Negara?

The importance of central bank independence has a lot to do with inflationary concerns. By independence, it typically means independence from political pressure. That entails strict separation between the central bank and the government. The central bank is not answerable to the government in general and the government does not represent the central bank. These two different entities are of two different minds. If they ever agree with each other, then it is necessarily a coincidence, or a conclusion achieved independently of each other. In its strong form, it is not achieved through any kind of discussion between the two parties.

It is feared that without independence and with exposure to political pressure, the central bank would embark on a populist policy, just as a democratic government that is susceptible to popular sentiment would. In times of crisis and without independence, the bank could run a loose monetary policy to appease the masses, eventually causing unacceptably high inflation simply by the operation of expectations.

The relationship between inflation and the independence of the central bank is widely known and is largely accepted within the field of economics: independence is correlated is an environment of low inflation.Ā There are ample evidence for this.[1]

This is probably not subscribed by some Members of Parliament in Malaysia. Or they are unaware of it. Or that they define it very differently from what it is unusually understood. Whatever it is, three MPs are heading in the direction of subverting the idea.

According toĀ The Malaysian Insider, MP for Kuala Selangor,Ā Dzulkefly Ahmad of PAS wanted the Prime Minister to justify the recent rate hike by the Bank Negara. MP for Lembah Pantai Nurul Izzah said in the same report, despite stating she “wasĀ not asking the government to intervene”, she effectively blamed the government for the rate hike.[2] In the Parliament today, MP for Rembau Khairy Jamaluddin asked the Finance Minister to explain whether the Bank Negara would change the base interest rate and the reserve requirement between now till the end of the year.[3]

Truly, the concern for the rate especially is not for the Prime Minister, the Finance Minister or any person of their choosing to explain. These questions should be directed to the Bank Negara itself.

If these elected officials do try to explain it, then it will create a perception that the government and the Bank Negara are in cahoot in managing monetary policy. A mere hint of relationship as far as monetary policy is concerned is damaging to the idea of independence. The relationship suggests that the central bank in some ways is responsive to popular demand; popular demand is a code word for loose monetary policy.

What will make it worse is the possibility of the government flip-flopping, which is not rare at all in Malaysia. For a central bank that is not independent, any u-turn is especially damaging to theĀ the credibility of the bank. Without credibility, the bank can say goodbye to its ability to manage inflation expectations.

Because of the possible implications, the Prime Minister and his Cabinet members should be careful in answering any of such questions.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] ā€” The degree of central bank independence varies considerably across countries. Several authors including Bade and Parkin (1982), Alesina (1988, 1989), and Grilli, Masciandaro, and Tabellini (1991) found that more independent central banks are associated with lower levels of inflation. This note investigates whether one can find a correlation between central bank independence and the level and variability of real economic variables such as growth, unemployment, and real interest rates. Our conclusion is that while central bank independence promotes price stability, it has no measureable impact on real economic performance. [Alberto Alesina. Lawrence H. Summers. Central Bank Independence and Macroeconomics Performance: Some Comparative Evidence. Journal of Money, Credit, and Banking. May 1993]

[2] ā€” PAS MP for Kuala Selangor Dr Dzulkefly Ahmad said that the prime minister, who also holds the finance portfolio in cabinet, should explain the move, which surprised economists who were expecting Bank Negara to maintain the benchmark lending rate to preserve the countryā€™s growth momentum in the face of dimming global economic prospects.

…

PKR MP Nurul Izzah Anwar also stressed that they are not asking the government to intervene in Bank Negaraā€™s policies but said that it was important for the finance minister to clarify what she claimed were ā€very inconsistent justifications.ā€Ā

Nurul said that while the government could be trying to cool down the investment climate with an eye on keeping a lid on inflation, she was unconvinced that an interest rate hike could also drive the growth of the local domestic economy at the same time. [Melissa Chi. Justify May interest rate hike, PR MPs tell Najib. Journal of Money, Credit, and Banking. June 21 2001]

[3] ā€”Ā Tuan Khairy Jamaluddin [ Rembau ] minta MENTERI KEWANGAN menyatakan apakah Bank Negara Malaysia berhasrat untuk menyemak atau meminda Kadar Dasar Semalaman (Overnight Policy Rate) dan Keperluan Rizab Berkanun (Statutory Reserve Requirement) bagi bank-bank tempatan sehingga akhir tahun ini. Sila jelaskan sebab-sebabnya sekiranya ya mahupun tidak. [Order Paper. Dewan Rakyat. June 21 2001]

Categories
Economics

[2237] Of why I prefer fiat currency to commodity-backed currency

Libertarians generally are in favor of commodity-backed currency. This is largely based on typical libertarian attitude towards the state: do not trust them.

Others who are not quite libertarian share the same idea about trust. They really have trouble believing that a piece of paper worth something when it is only backed by some promise. They rather have a piece of paper that essentially put a claim on some asset. Typically, that asset is gold although it does not have to be gold.

A step beyond the issue of trust is the fear of inflation and the belief that commodity-backed currency is not inflationary. It is a myth that commodity-backed currency is not inflationary however. Theoretically, gold supply can increase to affect the quantity of money in the economy directly and thus, creating an inflationary environment. Admittedly, there is more inflationary risk associated with fiat currency than to commodity-backed currency.

Before we go farther down the road, let me clarify one thing: I do not think highly of commodity-backed currency when it is juxtaposed with fiat currency.

As a libertarian, I need to rationalize my position through libertarian means, especially so when I am going against the libertarian stream. This entry is partly where I do that rationalization.

I would like to address the worry of inflation first because it is more general than specific libertarian concern. I will visit the libertarian concern soon after.

The inflationary concern has been overblown by proponents of commodity-backed currency, and especially by supporters of gold standard.Ā Despite the ā€Ėœdistrust-the-governmentā€™ mantra, modern monetary institutions these days are good at managing inflation. The occurrence of hyperinflation, which is really the problem, is rare. As long as those institutions are independent under normal everyday circumstances, inflation can be contained, or at least inflation attributable to changes in money supply. Note that not all inflation is due to increase in money supply.

On the issue of libertarian distrust of government, that does not really automatically translate into support for commodity-backed currency or more specifically, for gold standard. Private banks, for instance, can issue fiat currency. The only prerequisite to fiat currency is trust, no matter who the issuer is.

But what about trust in general, be the issuer is the government or some private entities? I would like to argue the use of commodity-currency is a society that suffers from trust deficit. I will save that for another day.

Finally, the practical reasons for fiat currency vis-ƃĀ -vis commodity-backed one are unrivaled. One of those major reasons is flexibility: I value the flexibility that comes with fiat currency, which commodity-backed currency does not have. The flexibility is this: fiat currency can completely mimic commodity-backed ones while the reverse is untrue.

Flexibility is especially valuable in times of economic crisis. Perhaps, once I find myself in an economic foxhole, I tend to waver on the idea of limited government. But I would like to think that the flexibility of monetary policy allows the use of monetary policy as the first course of action when the other option is fiscal policy. I think this is a practical libertarian justification to the use of fiat currency.

Fiscal policy is more damaging to the idea of laissez-faire than monetary policy. Fiscal policy tend to have real programs associated with it while monetary policy is just, well, about money. Programs associated with fiscal policy often involve active government intervention in multiple fields. Meanwhile, the management of money involves only passive intervention. Between the two evils, I would vote for monetary policy. I am voting for monetary policy.

But that choice is available only when there is flexibility in the monetary policy. Without flexibility, the urge to engage on large fiscal policy can be too great to resist in time of crisis.

People do not like pain. In a democracy, doing nothing may not be viable. The democratic reality is that there is a populist element needs to be tended to, however unfortunate that is. With monetary policy, at least there is an avenue to do something and reduce the pressure for heavy government intervention.

Of course, both policies are not mutually exclusive but with monetary policy, the size of fiscal policy can be managed, compared to a scenario where there is limited monetary policy spectrum to choose from, i.e. when there is only commodity money.