Friday, November 7, 2014

BNM Watch: OPR Still On Hold

More or less as expected by just about everyone, yesterday’s MPC meeting has the OPR still on hold at 3.25% (excerpt):

Monetary Policy Statement

At the Monetary Policy Committee (MPC) meeting today, Bank Negara Malaysia decided to maintain the Overnight Policy Rate (OPR) at 3.25 percent.

The global economy continues to expand at a moderate pace…Looking ahead, while the overall global growth momentum is expected to improve, the growth forecast has been revised downwards due to weakening economic activity in a number of major economies. Consequently, the downside risks to global growth have increased. Volatility in the international financial markets has also risen.

For Malaysia, while domestic demand has continued to support growth, exports have shown signs of moderation. Going forward, domestic demand will still remain the key driver of growth…While the moderating trends will affect the overall growth prospect, the Malaysian economy is still projected to remain on a steady growth path.

Inflation is projected to trend higher for the remainder of the year and will continue to be above its long-term average next year due to domestic cost factors….

I didn’t agree with the original decision to raise the OPR earlier this year…but once that was done, I would’ve preferred to have seen interest rate normalisation carried through. There’s a potential credibility issue with just raising interest rates once – you might be seen as being to dependent on incoming data, as opposed to seeing broader trends in the economy and in trade.

But what’s done is done, and for now, it looks as if BNM will keep the monetary policy stance on hold for at least the next 2-3 sittings. The key here will be the behaviour of consumers and the extent of the recovery in trade.

Will consumption be brought forward before GST rolls out in April (I think the effect will be at best mild)? Will wage growth keep up with the changes in prices (not likely for the next six months unless there’s a revision in the minimum wage)? Will households resort to borrowing to maintain their living standards (the credit taps have been shut off)? Will Europe (actually the Germans) do the right thing and let the ECB do quantitative easing (not hardly)? Since the answer to all these questions is at best a maybe, there’s still no compelling reason to raise interest rates any time soon.


  1. hello,
    I have a question about the statement: "Will Europe (Actually the Germans) do the right thing and let the ECB do quantitative easing (not Hardly)". What exactly do you mean with "The right thing" and "quantitative easing"?

    1. @Wonni

      These posts summarise my viewpoint on the Eurozone:

      They're old, but nothing has fundamentally changed since.

    2. Hello hishamh,
      Thanks for your reply.
      I have read the two posts and have to say that I do not agree with them that the euro can only survive if "Germany leaves the euro zone". Germany is a major engine of the European economy and is very successful in the fight against debt in their own country and Germany tried everything to strengthen the euro. We should be pleased with the commitment of Germany and should try to find another way to cut the budget deficit of states and to strengthen the euro. What do you think about this?

    3. @Wonni

      "Strengthening" the Euro would be the very worst policy for Europe to follow - outside of Germany that is.

      There's a number of ways of looking at Europe's problems:

      1. Germany is many times more productive than the rest of Europe. This manifests itself as Germany running a trade surplus, both with the world and with the rest of Europe. This causes an inflow of capital into Germany, and away from the rest of the Eurozone.

      2. In the ordinary course of events, this imbalance in productivity and prices can be handled by adjusting the external prices between economies, i.e. with an appreciation of the German currency and a depreciation of everybody else.

      3. However, because Europe uses only one currency (the Euro), such an adjustment cannot occur. Instead of an external price adjustment, you have to use an internal price adjustment instead. In effect, Germany needs to pay its workers more (i.e. inflation) while everybody else in the Eurozone has to pay their workers less (i.e. deflation). However, Germany continues to practice wage suppression (wages increasing less than productivity). Due to nominal price contracts (people are employed at a certain wage, and also have nominal price liabilities like mortgages), deflation in other countries manifests itself in company bankruptcies and higher unemployment.


    4. [2]

      Here's another way of looking at it:
      1. The European Central Bank manages monetary policy by targeting inflation across the whole Eurozone. In practice however, this means targeting inflation rates in the very largest economies i.e. Germany and France, and Italy.

      2. However, interest rates appropriate for the core economies do not mean interest rates appropriate for the rest of Europe, because of differences in business cycles. Since Germany required reflation after the integration of East and West Germany in the 1990s, interest rates for the whole Eurozone were too low for many of these economies in the 1990s and early 2000s (the pegging of European currencies to the Deutsche Mark before the introduction of the Euro, effectively transmitted German monetary policy to the rest of Europe), which led to the buildup of both public and private debt.

      3. Given productivity differentials (i.e. different inflation trajectories) the ECB’s current policy effectively means appropriate monetary policy for Germany, but totally inappropriate policy for everybody else (including France and Italy).


    5. [3]

      Here’s yet another way of looking at it:

      1. There are three ways to handle a heavy public debt burden – a) pay it down; b) grow out of it; and c) inflate it away.

      2. Paying it down, i.e. fiscal austerity, only works if you can counterbalancing the reduced growth from lower net government spending by expansionary monetary policy e.g. Canada in the 1990s. Otherwise, raising taxes or reducing government expenditure reduces overall growth, which simultaneously reduces the yield from tax. You end up with no improvement in either deficit or debt, but with lower GDP and higher unemployment. This is the route favoured by the Germans, and very obviously it is not working for anybody else but them. The reason for that goes back to the fact that ECB monetary policy is appropriately loose for Germany, and inappropriately tight for other European countries. Another way of saying this is the German cost/price level is too low (Germany needs inflation/revaluation) and everybody else is too high (they need deflation/devaluation).

      3. Growing out of a debt burden means either expansionary fiscal and/or monetary policy. Because of the constraints of an ECB policy geared towards Germany, expansionary monetary policy is out. Because of German pressure, fiscal expansion is also out.

      4. Lastly, debt can be inflated away. Yet ECB policy is too tight (real interest rates are too high) for the likes of France, Italy, Spain, Greece, Portugal et al, causing an overly strong Euro and low inflation when the correct policy approach is to engineer a weaker currency and higher inflation, which would boost both growth and inflation and thus allowing the real burden of debt to fall. But because this would mean inflation in Germany would be much higher than the rest of Europe, the Germans don't like this solution.

      Because of the constraints of a monetary union, the ECB must take a one-size-fits-all approach. Yet with economies with very different characteristics lumped together, this means policy will be at odds with the requirements of one or more countries.


    6. [4]

      There are a couple of ways to resolve this dichotomy.

      The first is for a full fiscal union - every country in the Eurozone must give up their sovereign right to tax and spend in favour of a pan-European government. This will allow fiscal transfers between countries to make the necessary counterbalance to productivity/price differentials, similar to what occurs within countries today.

      The second solution is for Germany to leave the Eurozone, or alternatively break it up entirely.

      The current approach of muddling through resolves nothing of the fundamental contradictions in the Euro's institutional arrangements. In the meantime, the countries that are forced to undergo deflation, like Spain and Greece, have endured more than five years and counting of recession, with unemployment in the millions. There's a whole generation of youth who have never had the opportunity to work (Spanish youth unemployment is over 25%, Greece over 50%), and have little to no prospects.

      I am hardly alone in this analysis. Plenty of prominent economists are saying the same things, and some have even taken the same extreme position as I have, that Germany has to go if the Eurozone is to survive.

      Whichever way you look at it, the insistence on focusing on repaying public debt at the cost of jobs and destroyed economies is at best misguided, at worse barbarous.

  2. Hello hishamh,
    And thank you for your very informative response. You got me practically inundated with information. I have to think about it very carefully about it. And thanks for all those Links. So I can read much more about this topic.

    You are really helpful and you answer all my questions. Such a willingness to help is very rare.
    I have another question for you. Would you be so kind and click on the next link? It appears a survey, which I have created. I perform it for my bachelor thesis. It's about blogs on the internet. The survey is short and completely anonymous. Would you do me that favor?
    It would help very much.