Centralised monetary policy needed to manage inflation

Wong Chin Yoong

Monitoring of food prices should not be left to consumers to do by themselves, it requires centralised co-ordination. – The Malaysian Insight file pic, February 2, 2023.

ECONOMY Minister Rafizi Ramli said some weeks ago: “Theoretically when inflation rises quickly, then the way to limit the demand is to increase the overnight policy rate (OPR), so that there is less money in the pocket.

“I’m not sure how significant OPR would be on inflation. It remains to be seen, because the main driver of inflation is food prices, like the food away from home.

“If Bank Negara Malaysia (BNM) decided to maintain the OPR at the risk of fuelling inflation, in order to have the best of both worlds – interest rate maintained at 2.75% while inflation is receding – consumers have to play the role of monitoring the unfair pricing practices.”

He is right to point out where the shadow of the tree falls. Prices for food and non-alcoholic beverages, as well as hotels and restaurants, have been stubbornly high for months.

Of all the subgroups in food and non-alcoholic beverages, food away from home, meat, together with milk, cheese, and eggs, are where the sins reside.

However, Rafizi’s prescription doesn’t live up to the root of the problem.

What is happening is an increase in prices generally across the board, rather than predatory pricing by a particular business entity, unless we are ready to believe that all hotels, restaurants, cafes, hawkers, and mamak stalls are conspiring to bump up prices, collective monitoring is irrelevant at best, and counterproductive at worst.

Rafizi must be smart enough to realise that collective monitoring can only be effective under a centralised mechanism.

Intuition is no stranger to us. We never place the burden of monitoring bank loans on depositors, although they have every claim to stake in ensuring sustainability, simply because monitoring is costly and a sole burden, while the benefit of a successful intervention is shared by everyone.  

When the trade-off between private cost and benefit is on the down side, asking depositors to monitor in a decentralised and unco-ordinated fashion, is destined for a failure.

That is why we need BNM to supervise banks. Likewise, retail prices monitoring.

While arguments for collective monitoring may or may not earn him a political point, it certainly deserves no economic score.  

The view on monetary policy doesn’t sit well with Economics 101 either. Yes, borrowers have fewer ringgit to spend when BNM raises the interest rates.

Never forget though savers have more ringgit to spend in the future as well.

Therefore, an interest rate hike is not about taking away the money from your pocket, but redistributing it somewhere else.

It shifts the purchasing power from debtors with greater propensity to spend to creditors with lower willingness to spend, and it delays today’s spending further into the future so that overall spending grows slower now.

After all, food and beverages are not the only component in the computation of the consumer price index.

Stubbornly higher food inflation will be offset by the disinflation in interest-sensitive spending components, cooling off the overall inflation.   

Think otherwise. Suppose monetary restraint is not in the picture, and purchasing power remains in the hands of the eager spenders.

Even if collective monitoring works to deter the greedy increases in food prices, sparing consumers the purchasing power, it is not difficult to see through what happens next: the strong purchasing power will cause inflation somewhere else.   

Monetary restraint as such, therefore, is always and everywhere effective – though with a delay – irrespective of the sources of inflation.

Until it is disavowed politically. By openly casting doubt on the viability of a monetary policy stance in the capacity of a minister of relevant portfolio, it runs the risk of jeopardising central bank credibility.

Losing the policy credibility, even by an inch, can be disastrous to the disinflation initiative.

At worst, we’re going to have the worst of both worlds: persistently high inflation and the catching-up rising interest rate at the expense of a potential recession.   

To bend the tree, not the shadow, let each authority play its role. Monetary policy was and is still the best tool in inflation moderation.

For the disinflation we’re witnessing now and in the coming months, while partly it can be attributed to the receding global supply shocks, interest rate hikes in previous months will be where the remaining credit is due.

However, monetary restraint can do nothing more than a business cycle moderation. Price stability over the long run requires a sustainable supply chain and productivity growth.

For this, the federal government has the absolute authoritative claim via tax incentives and financial transfer.       

Once financial and monetary authorities are at their best in doing their jobs, that’s when the people can have the best of both worlds. – February 2, 2023.

* Wong Chin Yoong is a professor of economics at Universiti Tunku Abdul Rahman, Kampar campus.

* 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.

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