Monetary Policy For Maintaining Low, Stable Inflation In Malaysia

The main thesis of this paper is that low, stable inflation, implying price stability, is important for promoting and sustaining economic growth in the midst of shocks of both domestic and foreign origin. The paper makes an overview of inflation, inflation volatility and monetary policy in Malaysia since the late 1950s and provides some evidence for a link between inflation volatility and economic growth. As part of determining the appropriate strategy of monetary policy for price stability, the paper investigates some monetary relations—namely the stability of the money-demand function and the linkages among money, output and prices—which form the foundation of a money-based monetary policy strategy under a flexible exchange rate system. The empirical results suggest that the narrow money-demand function in Malaysia remained stable over the period 1971–2012 and that cointegral-causal linkages existed in this country among money, output and prices throughout this period. These results give credence to deployment of monetary aggregates as an instrument of monetary policy, especially when the flexibility, effectiveness of a zero-bound interest rate remains doubtful as an instrument of monetary policy in a low-inflation environment. Nevertheless, Malaysia has apparently taken the stance that money does not matter insofar as inflation and its volatility are concerned. The money growth rate has remained volatile in this country and contributed to high and volatile inflation for most of the time over the study period. Some empirical results suggest that despite the impression of rule-based monetary strategy, Malaysia did not conduct a rule-based monetary policy—within either monetary targeting or inflation targeting—to keep inflation low and stable. Instead, the Bank Negara Malaysia (central bank of Malaysia) used discretionary monetary policy to achieve multiple objectives, including rapid economic growth. An outcome of this policy was elevated inflation volatility, which affected real interest and exchange rates and raised output volatility. The paper concludes that improved monetary policy transparency and elevated monetary policy credibility are expected to make a rule-based monetary policy more effective and keep inflation low and stable.