Monetary Policy

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The Objective and Formulation of Monetary Policy in Malaysia Anas Faizal Aning & Rubin Sivabalan Monetary Assessment & Strategy Department 6 July 2010 Auditorium, Bank Negara Malaysia 2.30-4.30pm

DISCLAIMER: Views expressed in this presentation are those of the author and do not necessarily represent those of BNM nor are they necessarily 1 Presentation to TAR College, July2010 endorsed by BNM.

Presentation outline
Monetary Policy and Macroeconomic objectives
The importance of price stability

The role of monetary policy Monetary policy framework in Malaysia

Presentation to TAR College, July2010

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What is the objective of policymakers?

“The ultimate objective of all public policies is to improve the living standards (welfare) of its nation”

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What is the objective of policymakers?
To improve the standard of living, one of the public policy objectives is to promote robust and sustainable economic growth

GDP (or GNI) is a crude proxy for measuring the standard of living, i.e.

Y = C + I + G + (X-M)

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What is macroeconomic stability?
INTERNAL Balance
Inflation is low and predictable Fiscal policy is stable and sustainable

EXTERNAL Balance
BOP situation is perceived as viable Real ER is competitive and predictable

Stanley Fischer (1993)

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How does price stability contribute to sustainable growth?

Facilitates decision-making

Promote efficient allocation of resources Price stability Reduces distortionary effects on the tax system Prices remain an effective signal for demand & supply Better conditions for growth

Reduces the cost of hedging

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Other costs of Inflation : What you inevitably face when prices increase The erosion of value of money & living standards Redistribute income from savers to borrowers if real interest rate is negative Shoe leather and menu costs Inflation unnecessarily pushes households into higher tax brackets Inflation encourages households to invest for speculative purposes Higher domestic inflation relative to abroad, leads to loss of international competitiveness. Uncertainty of future prices may discourage investment and saving. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future.

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Inflation increases the cost of living
Cost of Breakfast (1956 - 2005)
300

Nasi Lemak
250 200
Sen

Teh Tarik

7% per year

90

150
70 150

100 50
3 30 40 40 50 45

60 55 90 75 60 20 30 15

120

10

0

5

56-60

61-65

66-70

71-75

76-80

81-85

86-90

91-95

96-00

01-05.

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Inflation reduces real purchasing power

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Higher inflation associated with lower growth
Real GDP vs. Inflation

Beyond a certain threshold (kink), inflation is really harmful to growth Kink; 1-3% for industrial countries, 7-11% for emerging markets Khan and Senhadji (2001)

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Structural policies for long-term objective, while counter-cyclical policies for medium-term sustainability Macroeconomic Policy Structural policies Types of Policies Purpose Desired Outcome Increase potential output

Industrial policy, Labour policy, Education policy, Banking policy

Productivity, Efficiency, Competitiveness, Flexibility

Counter-cyclical Monetary policy policies Fiscal policy

Contain risks of recessions (deflation) and high inflation

Stable prices with sustainable pace of economic growth

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“Monetary policy comprise of actions by a central bank to influence the availability and cost of money and credit to help promoting national economic goals” The Federal...
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