(Revised) Malaysia Central Bank’s Decision (2)

In ECON 411 –Monetary and Financial Theory class, we learned from Professor Kimball how effective negative real interest could be in order to stimulate the economy from the recession. By targeting long term inflation rate around 2 percent and setting nominal interest rate near zero, negative real interest rate can be achieved as shown by the Fisher Equation. US, Japan and many other countries used this monetary policy in order to stimulate the economy when financial crisis occurred in past years.

Wall Street Journal article (Rising Inflation in Malaysia Turns Up the Heat on Central Bank) points out Malaysia’s recent monetary policy and its outcome. Data which came out on Wednesday, February 19th showed that consumer price rose 3.4% in January from a year earlier. It is Malaysia’s fifth straight months of gains and fasted pace in two and half years. Malaysia’s economy did grow at a strong rate past few years, and now Malaysia’s central bank is planning to raise the interest rate from 3.00% to 3.25 % as a measure of bringing the price level down. According to Wall Street Journal article (Malaysia’s Central Bank Stands Pat Again), Malaysia have been keeping its nominal interest rate at 3.00% for last three years. Due to its relative low interest rate compared to its inflation, Malaysia could achieve a fast economic growth, maintaining GDP growth rate of 4.7% in 2013 when many other countries suffered from the turmoil.

Two graphs below show us Malaysia’s economy in a more detail. Malaysia’s unemployment rate has been decreasing steadily to 3.2% from 4.1% in 2009 while its GDP per capita increased from $5984 to $6764 in last four years. From those two graphs, we can tell that Malaysia experienced a fast recovery from its economic turmoil in 2009.

malaysiaunemploymentmalaysiagdp

The main reason for its fast recovery is Malaysia’s relatively low interest rate for last four years. In order to take a closer look at Malaysia’s monetary policy for past years, I plotted inflation rate, nominal interest rate and real interest rate in one graph. Inflation rate and nominal interest rate data are from World Bank, while real interest rate was calculated using the Fisher equation. It can be seen that negative real interest rate was achieved in year 2007-2009 and 2011, helping the Malaysia economy to recover in a fast pace with lowering unemployment rate and increasing GDP per capita. The real interest rate went down as low as negative 5% in September 2008, being a strong stimulus for recovery.

malaysia rate

Malaysian government started to slow down its government spending, which could decrease domestic demand. Central bank’s decision of increasing interest rate could also reduce domestic demand, as people will save more money instead of spending it in domestic market due to higher interest rate. However, economists forecast that Malaysia can still achieve strong GDP growth of 5.0% to 5.5% this year, thanks to its strong export.

Nonetheless, Malaysia’s stock market has been showing a strong positive upward trend since its low 850 index points in 2009 shown in graph below. Thanks to Malaysia’s monetary policy over past years Malaysia’s stock market has reached its highest of 1875.52 index points in 2014. This may worry some people with monetary policy with low interest rates- asset bubbles. Although its increasing rate is gradually slowing down, additional measure (such as increasing nominal interest rate) can help control the economy from over stimulating.

malaysia stock market

Malaysian central bank’s decision of increasing interest rate is a smart decision to hold inflation rate and curb dangers of overspending and control debt as well. When I read the articles and thought of Malaysia’s decision, I related this to US’s tapering of quantitative easing. US, although its unemployment rate is not meeting government’s goal fully, started to taper as US did achieve some economic recovery in recent years. “Tapering” is as important as “quantitative easing,” as economy could be over-stimulated and over-inflated and it could be very dangerous. Malaysia showed how effective “negative real interest rate” is, from its high GDP growth last year. If Malaysia can also show how they are able to control inflation and prevent “over-stimulating” the economy while keeping its economic growth strong just like economists have forecasted, it will be a good example of how negative real interest rate is a good, non-harmful stimulus for economic growth.