EFFECTIVE monetary policy is not just about raising or lowering interest rates by the right amount at the right time, it is much more about effective communication of the reasons why interest rates are changing.

Credible, accountable and transparent policy announcements help people to feel confident that the changes in policy are properly justified.

Yesterday, Bank Negara Malaysia (BNM) provided a very clear explanation of its decision to raise the overnight policy rate (OPR) by 0.25% for the second time in two months.

In the spirit of greater transparency, the publication of the monetary policy statement was followed by an open and detailed briefing for economists and analysts, which cleared the air on many issues that have been of concern.

First, we learned that BNM is more confident about the recovery in Malaysia 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 EPF withdrawals for example, also add to its view that the recovery is and will be more robust.

As such, it is maintaining the positive forecasts for growth in the range 5.3-6.3%.

It is also realistic about external headwinds including the impact from rising international and local cost pressures, the military conflict in Ukraine and the strict containment measures in China, which pose risks but do not fundamentally reduce its baseline projections.

Second, we learned that BNM is not targeting inflation with these interest rate hikes but is taking a more holistic view consistent with its wider mandate.

Its inflation forecasts are maintained at 2.2-3.2% for headline inflation and 2-3% for core inflation, and so there are no particular or new inflationary concerns to be targeted with higher interest rates.

In particular, according to BNM’s analysis, higher consumer and business demand will not cause demand-pull inflation because of excess supply capacity.

As demand rises the slack in supply will be taken up without a rise in prices. So although the prices of some items may remain high, we will not see prices increasing as much in the future.

We also learned that BNM maintains its long-held position that changes in interest rates are not caused by, ‘following the Fed’ or ‘chasing the exchange rate’.

BNM confirmed it has no exchange rate target and cannot influence the level of the exchange rate systematically.

At best, it can moderate short-term volatility but they cannot use interest rates and exchange rates to influence domestic inflation, for example. This is clear and correct.

Third, its main argument for raising the OPR is to recalibrate interest rates across the economy.

In the face of a more robust recovery, it calculates that we no longer need the low interest rates necessary in the recent crisis and that the economy can now afford higher rates without jeopardising growth. In a sense this is a statement of confidence in its growth forecasts.

This ‘normalisation thesis’ is common across many central banks around the world but higher interest rates do raise financing costs for variable interest loans, which are the greater number of loans and the main type of loans held by the B40 group.

BNM calculates that the effect of the two recent interest 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 are clearer about the reasons for the interest rate hikes but now the big question is: when will we reach the ‘normal’ or ‘recalibrated’ interest rate?

Or, to put it another way: when will interest rate hikes stop?

BNM has an honest answer to these questions, which is that it does not have a specific public target interest rate and that the decision-making process by the monetary policy committee (MPC) is holist and aims for a collegiate consensus, rather than a majority vote as in other central banks.

So the issue of the ‘normal’ interest rate remains open.

BNM also acknowledged that there are some signs of structural change in the economy, particularly in the services sector, in digitalisation and e-commerce and in the jobs market.

This means that the proper interest rate of the past may not be the proper interest rate of the future.

We have also long argued that the impact of the Covid-19 lockdowns has caused a structural break in the Malaysian economy, which needs further research and analysis to understand.

This is essential because we need to know whether the ideas and models of the past are useful in policy decisions of the future.

More broadly, we also need to understand the new drivers of economic growth and the things that will help the economy gear up better in the future.

This is broader than the monetary policy remit of BNM but it is an essential research area that we must focus on now. – July 7, 2022.

* Professors Paolo Casadio and Geoffrey Williams are economists.

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.