Central banks have the tendency to raise interest rates to fight inflation and lower them when the economy is slowing
by NUR HANANI AZMAN / pic by MUHD AMIN NAHARUL
BANK Negara Malaysia (BNM) is not expected to raise its benchmark Overnight Policy Rate (OPR) soon because that could block the supply-side adjustments needed in the domestic economy to increase supply with additional investments.
Centre for Market Education CEO Dr Carmelo Ferlito said central banks have the tendency to raise interest rates to fight inflation and lower them when the economy is slowing, but all this does not really work automatically and perfectly, otherwise we could easily avoid economic crises.
He said when the Covid-19 pandemic hit, governments around the world rapidly increased expenditure with very little access to increased funds from sources like taxation.
The gap was filled with more borrowing and by money printing under quantitative easing or similar programmes depending on the country.
“This led to a significant increase in money stock, but the lockdowns led to a fall in the speed at which money was circulating. This has created an indeterminate change in monetary demand but now as countries try to normalise, the increased money stock and an increased money flow adds significantly to aggregate monetary demand.
“Within 12-18 months from these phenomena, the economy will suffer inflation. That is happening now in most countries and central banks and governments are misleading people into thinking that higher inflation is caused by supply-side problems such as energy price rises, supply chain difficulties.
“The inflation now is the result of government overspending and monetary mismanagement; supply-side shocks are not enough to generate generalised inflation, however increased money supply does,” he told The Malaysian Reserve.
BNM maintained the OPR at an all-time low of 1.75% at the monetary policy committee (MPC) meeting on Wednesday, which was in line with economists’ expectations.
Going into 2022, the central bank stated that growth momentum is expected to improve, supported by expansion in global demand, higher private sector expenditure in line with the resumption of economic activity and continued policy support. Risks to the growth outlook, however, remain tilted to the downside due to external and domestic factors.
“Headline inflation is likely to average within the projected range of between 2% and 3% for 2021, having averaged 2.3% year-to-date.
“Underlying inflation, as measured by core inflation, is expected to average below 1% for the year. Moving into 2022, headline inflation is projected to remain moderate,” BNM stated in the policy statement on Wednesday.
Kenanga Investment Bank Bhd thinks the probability of BNM to raise the OPR would be higher going into the second half of 2022 especially on the expectation of firmer domestic driven demand growth.
“However, that would be subjected to the timing of the possible snap election next year,” the investment bank stated in a report on Wednesday.
Ferlito said fiscal and monetary stimuli caused by the pandemic created a one-off misallocation of resources and causing supply chain problems and holding back economic growth. That’s the reason some are worried about stagflation.
He stressed that the only way out of this situation is for governments to cut back expenditure immediately to pre-pandemic levels but that may not happen as there’s temptation on governments to maintain spending on other things instead of on the Covid-19 pandemic.
“This would be a big mistake. Governments should be planning to balance their fiscal budgets within the next few years. Central banks need to slow the growth in money supply and manage monetary demand to grow a little faster than output to achieve their inflation target (2%).
“The inflation they have already caused needs to work through the system and certainly needs no more fuel from any excessive monetary and fiscal expansions. It would be a mistake for a central bank to try and reverse policy and create a monetary contraction. This would be a case of two mistakes not making things right,” he said.
Finally, the central bank needs to more closely align its official repo rate with market rates after which Ferlito said we will begin to see a rebalancing of the economy, stronger, freer markets and accelerating economic growth.