FACULTY OF MANAGEMENT

SEMESTER 5 / SEP 2017

BBEK4203

PRINCIPLES OF MACROECONOMICS

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CONTENT

INTRODUTION
1.1 Definition ......................................................................................................... 2-4

MONETARY POLICY ON MALAYSIA’S

2.1 Effects of the monetary policy on Malaysia’s economic growth rate ............. 4-6

MONETARY POLICY ON RATE OF UNEMPLOYMENT IN MALAYSIA

3.1 Effects of the monetary policy on rate of unemployment in Malaysia. ........... 6-8

BANK NEGARA MALAYSIA'S POLICY APPROACH

4.1 Financial Imbalance. ...................................................................................... 8-10

STRATEGY ECONOMY GROWTH

5.1 Encourage Private Investment. .................................................................... 10-10
5.2 Strengthening the Competitiveness Of The Country ................................... 11-11
5.3 Building New Sources of Growth. ............................................................... 11-11
5.4 Improve Delivery System Effectiveness. ..................................................... 11-11
5.5 Ensuring Balanced, Inclusive and Sustainable Economic Growth. ............. 11-11

CONCLUSION ...................................................................................................................... 12-12

REFERENCES ...................................................................................................................... 13-14

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1.0 INTRODUCTION
Macroeconomics is a case study of aggregate (overall) economic matters. The study on economic
variables is carried out in larger and more contextual contexts such as growth and recession,
unemployment, the amount of money flow, and inflation rate in the State. According to Sadono
(1999), macroeconomics is a comprehensive study of the economy of a country.
In the macroeconomic field, this economic variable refers to statistical data on a country's
economic activity. The data will be assessed based on the following aspects:

i. the overall performance of the economy and the linkages between the sectors that exist
in an economy,
ii. studying the determination of output or output of the State and economic growth,
iii. studying issues or economic issues such as recession, unemployment, inflation, and
country spending.
iv. studying the policies used by the government in influencing and determining national
economic performance and effectiveness in addressing the economic problems faced.

Malaysia has scrutinized with various of exchanged rate regimes, capita control, and monetary
policies strategies over the past five decades in order to improve its microeconomic management
and maintain monetary stability Monetary framework was involved in changing economic and
financial environment overtime from the monetary targeting in 1973-1996 to the interest rate
targeting with floating exchange rate in July 2005 till present, according to Othman (2017).

In year 2014, Bank Negara Malaysia (BNM) implemented the new interest rate policy to conduct
of monetary operation. BNM adopted policy rate that is closely linked to another interest rate and
has introduced enhancements to its monetary operating procedure. Beneath the new framework,
Overnight Policy Rate (OPR) replaced the 3 months interference rate as the index of monetary
policy posture. As shown in Fig 1.0, operating target, i.e., average overnight interbank rate (AOIR)
with OPR as target, firmly restrained by the BNM.

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 Figure 1.1 BNM’s Current Monetary Policy Framework.
Source Bank Negara Malaysia

The selected article is about “The Monetary Policy Statement” from Bank Negara Malaysia
(BNM). The news published that the meeting with Monetary Policy Committee (MPC) of Bank
Negara Malaysia decided to maintain the Overnight Policy Rate (OPR) at 3.00 percent.

Refer to BNM (2014), Monetary Policy Committee (MPC) accommodate the level monetary base
accommodation by raising Overnight Policy Rate (OPR) by 25 basis points to 3.25% on July 10,
2014, in the circumstances strong growth prospects and inflation which is projected to remain
above average in long term. Attempts to return monetary conditions in normalization is also
intended to reduce the risk the formation of financial imbalances which could affect the growth of
prospects the Malaysian economy. Although there is an increase in the OPR, monetary conditions
continue to support economic activity during the year.

According to Nee (2014) written in Sundaily, the last hike in the OPR was in May 2011, which
saw an increase of 25bps to 3%, and remains unchanged until today. The OPR, consecutively, has
a brunt on employment, economic growth and expansion. It is an index of the overall health of the
country's economy and the banking system.

Since monetary policy stance has been adjusted for the last time in May 2011, the Malaysian
economy continues to record sustainable growth. Despite the challenging external environment,
the domestic economy recorded stable growth, driven largely by domestic demand. Based on this

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better growth performance as well as the domestic economic outlook that continues to be on a
steady growth path in 2014, the assessment shows that monetary policy provides substantial
support to the economy. Thus, at the beginning of the year, the MPC has realized that adjustments
need to be made to the accommodative level of monetary policy. This awareness also takes into
account the ongoing concerns about the risks of wider financial imbalances, following relatively
low interest rates and remain at the same level for a long period of time. Hence, the main
consideration being considered is to identify the appropriate time for the adjustment, taking into
account the constant assessment of the risk balance against growth prospects and inflation.

In early 2014, the Malaysian economy is projected to remain on track stable growth. Net export
growth is expected to improve, in line with the positive global growth outlook. Domestic demand
remains a key driver of growth, supported by favorable investment, primarily private investment.
The growth in private consumption is expected to trend towards its long-term average trend, after
recording a higher growth compared to the previous year's trend. By May 2014, growth in 2014 is
expected to be at the top level in the initial projection of 4.5% - 5.5%. However, the MPC
recognizes that growth risk will slow down, especially in relation to the risk of a modest private
consumption growth and weaker external demand.

There is an increased risk of higher inflation expected to rise above its long-term average of 3% in
2014 and 2015. This higher inflation expectation is driven primarily by domestic cost factors,
namely increased retail prices of fuel, electricity tariffs and tax implementation Goods and
Services Tax (GST) in 2015. However, the risk of excessive overflow effects from these
administered pricing adjustments is deemed to be relatively small, due to the moderation in
domestic demand and weak global price pressures expected to continue to occur for the rest of the
next period in 2014 and even up to year 2015. As such, inflation increases are assessed as
temporary, with inflation projected to decline to below its long-term average in the following year.

2.0 MONETARY POLICY ON MALAYSIA’S

2.1 Effects of the monetary policy on Malaysia’s economic growth rate.

Under the conditions of strong growth prospects, and inflation expected to remain above its long-
term average, MPC decided to make adjustments to the accommodative monetary base level at the
MPC meeting in July 2014. The attempt to restore monetary conditions to a more normal position

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also takes into account the to mitigate the risk of creating a wider range of financial imbalances,
which could affect the prospects for medium-term growth. While the implementation of macro
and micro prudential measures resulted in a more moderate growth in household indebtedness as
targeted, the MPC assessed that periodic and non-constant interest rate periods have steadily
created an incorrect risk situation and this has the potential to promote more financial imbalances
extends.

An example of adjustment to policy rates goes smoothly without interruption to the financial
system and the overall economy. Retail lending rates increased rapidly in line with the OPR change,
with the average base lending rate (BLR) of commercial banks raised by 25 basis points to 6.79%
by end-August 2014. Deposits are also given higher return rates for their savings, with a fixed
deposit rate (FD) called the average commercial bank for 1 to 12-month maturities increased
between 15 to 17 basis points to a range of 3.07% to 3.30% at the end of July 2014.

In 2014, interbank rates were influenced by market expectations that the OPR would be raised and
also by the real OPR increment. This expansion was an early boost to the uptrend for interbank
rates, as happened in 2014. In addition, for interbank rates with a maturity of more than 1 month,
the rate showed upward trend until the end of the year although the OPR was unchanged after July
2014. This is because banks are raising bids on interbank rates when banks are experiencing lower
deposit growth in the face of intense competition to secure stable funding. The competition for this
stable funding is to meet the new Basel III regulatory liquidity requirements that will be
implemented in stages, in the event of a slower overall deposit growth due to net outflows of capital.
As at end-December 2014, the spread between the Kuala Lumpur Interbank Offered Rate
(KLIBOR) 3-month rate increased by 61 basis points, exceeding the average spread for December
2012 to November 2013 by 21 basis points. Interbank money market transactions consisting of
deposits and receipts, banker's acceptance (BA) and negotiable instrument of deposits (NIDs) in
conventional and Islamic money market, registered a small increase to RM3.2 trillion.

Among the instruments, conventional deposits, unsecured lenders and loans, were the major
trading instruments accounting for 68.3% of the total. The excess liquidity aggregate in the system
decreased from RM336.8 billion by the end of 2013 to RM269.9 billion at the end of 2014 due to
capital outflow, especially in the fourth quarter following the expectation that the Federal Reserve

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will return interest rates to the appropriate level due to recovery the US economy and rising
concerns about the impact of the sharp fall in oil prices on the Malaysian economy.

3.0 MONETARY POLICY ON RATE OF UNEMPLOYMENT IN MALAYSIA

3.1 Effects of the monetary policy on rate of unemployment in Malaysia.

Although there are numerous studies and discussions rate of unemployment in Malaysia, there is
no clear or specific definition of this matter yet. In fact, unemployment is often defined according
to their symptoms or manifestations. These include investments that exceed the need for specific
sectors, excessive credit growth, sudden asset price increases, or fiscal imbalances and current
accounts. The most common and commonly identified symptom is asset price redundancy and
excessive credit growth. This unemployment reflects the provision of misleading resources and
the intermediation of funds channeled to speculative activity in the asset market

Given that the monetary on rate of unemployment can lead to increased domestic weakness and
are ultimately ineffective, it can lead to adjustments that impinge on stability in the economy and
pose risks to macroeconomic and financial stability. However, this phenomenon is not new. In the
past, the decrees often led to financial and economic turmoil, Kindleberger (2000). The recent
financial crisis experienced by the advanced economies, if financial imbalances are left
increasingly incrementally unnecessary, these imbalances can quickly and irregularly affect,
thereby causing financial and economic disturbances that may threaten price stability and
prospects long term economic growth. For emerging economies, in the post-crisis period, the more
relevant is the accommodative monetary base in the unprecedented advanced economy which has
caused a sudden capital inflow into these economies. This inflow can increase asset prices directly
as foreign investors buy assets, or may cause increased liquidity in the financial system, thereby
increasing the pressure on banks to lend, leading to credit boom and asset price bubbles. Such
inflows and subsequent downward pressures on the beneficiary country's interest rates may
significantly affect the open monetary and monetary economic conditions.

Basically, rate of unemployment is linked to financial imbalances which by driven changes in the
risk management practices of an economic agent and underestimates the widespread risk exposure
estimates. Through conventional monetary policy transmission lines, which include interest rate
channels, credit and asset prices, a prolonged period of low interest rates may encourage investors

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or savers to take greater risk. This can happen when the value and revenue are expected to remain
at a high level, or in the result of search results low returns from safe investment. These channels
aggravate the risk of financial imbalance when interacting with the risk-taking channel, Adrian
and Shin (2008), as prolonged low interest rates may lead to fundamental changes in perception
and risk tolerance.

With the risk-taking channel, prolonged low interest rates lead to lower risk assessments and
increased revenue search activity. From a bank perspective, a low interest rate environment
facilitates the repayment obligations of loans and increases the value of assets and collateral,
thereby reducing the bank's estimates of possible defaults. When improvements are misplaced as
being permanent, banks are more willing to give credit with conditions that do not necessarily
reflect the actual risks associated with the loan. Banks may also continue to find ways to use
methods other than conventional loan originating methods, and make more risky investments to
propel nominal returns. The cumulative effect of these actions is the increased risk level of bank
portfolio of asset portfolio, Adrian and Shin (2010).

The risk-taking channel is also closely related to liquidity, Borio and Chu (2008). When liquidity
increases, assets are easier to trade with little impact on prices (market liquidity) and easier funds
(liquidity funding). This increase in liquidity further enhances risk-taking behavior as lower risk
perceptions increase the willingness to participate in the asset market and carry out higher return
retrieval activities. For open economies, liquidity in the financial system can be substantially
affected by inflows of external sector. Capital inflows affect the asset market and financial position
of the bank, thus contributing to higher asset prices and increasing liquidity with banks.

As such, banks can meet credit demand while maintaining low or stable lending rates. In fact, more
than enough liquidity can increase competition for lending, thereby increasing the bank's
willingness to take risks. The combined effects can make monetary and monetary conditions more
relaxed even though the policy rate remains unchanged. Importantly, the likelihood of reversing
the inflows of capital and the adverse effects that it may have may not be fully accounted for by
banks and their customers

In an effort to assess the formation of unemployment/financial imbalances in the economy, the

Bank handles should be monitoring using various indicators, in the form of detailed and aggregate.
The main focus of monitoring is on aspects:

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 (i) the level of accommodation of monetary and financial conditions,
(ii) greater manifestation of risk taking, as well as
(iii) signs of excessive credit growth and the possibility of impairment of asset prices.

Monitoring monetary and financial conditions takes into account the various price and quantity
indicators that set the baseline for risk-taking behavior. These indicators include borrowing costs
and net returns on investments, as well as external sector inflows, liquidity surpluses and growth
in deposits. To assess risk taking practices, the Bank monitors the ability of banking institutions to
take risks by assessing their respective measured risks, and identify whether changes in these
capabilities result in changes in lending practices. Statistical analysis of trends and econometrics
estimates is carried out when assessing credit growth and asset market development. This is
complemented by continuous economic development monitoring, which helps differentiate the
basic factors with cyclical factors and speculation elements. For example, when evaluating the
housing market, the Bank analyzes structural factors such as housing supply, demographic changes
and construction costs, which may explain the difference in price trends relative to revenue. At the
same time, information such as initial loan settlement and the number of borrowers with multiple
loan accounts are also considered, to assess the level of speculative activity. This thorough
approach enhances the stability of assessment.

At the aggregate level, the Bank monitors the financial cycle. Financial cycle includes credit
changes and asset prices in time, reflecting changes in perceptions of risk and financial constraints,
Borio and Tsatsaronis (2012). Empirically, the cyclical climax has been shown to be closely linked
to the financial crisis, Borio and Tsatsaronis (2012). In addition, the financial cycle also typically
has a longer period than business cycle. Consequently, financial imbalances tend to increase and
be disposed of over a longer period than the business cycle fluctuations.

4.0 BANK NEGARA MALAYSIA'S POLICY APPROACH

4.1 Financial Imbalance

Given that unemployment/financial imbalances are typically increasing gradually with the
potential impacts of stability only appearing beyond the reach of conventional monetary policy
times, so early action on early signs of financial imbalance is important. In this regard, besides
giving a key focus on the balance of prospects for inflation and growth in the near term, the Bank's

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monetary policy decisions also take into account the potential risks associated with financial
imbalance, Bank Negara Malaysia (2010)

At the same time, the policy approach does not depend only on one basic tool, including monetary
policy, since the adjustment to policy interest rates will have a widespread effect on the economy.
As part of various Bank policy tools, policy measures such as macro and micro prudential
instruments are also considered and implemented to control financial imbalances. Coordination
with fiscal policy and introduction of tax measures further enhances overall effectiveness to
address financial imbalances. The decision to use monetary policy or other policy measures, or
any combination of these steps, to deal with unemployment/financial imbalances depend on their
respective benefits and costs relative to the current situation assessment. When imbalances are
valued at specific segments of the economy, targeted macro-and micro-prudential measures and
fiscal measures may be more effective in curbing surplus, at the same time, minimizing unwanted
cross-section overflow from policy to other economic segments, Zulkhibri, Ismail and Hidayat
(2016).

It is important to emphasize that while these other measures can complement monetary policy,
they are usually not a substitute for determining the exact level of interest rates. In this regard,
three key considerations support monetary policy action. First, if a loose and prolonged monetary
condition is likely to be the cause of unemployment/financial imbalance, the change in monetary
policy stance may be better than using other measures to address its symptoms, as the cause of the
distortion is directly addressed. Secondly, if there is any indication that financial imbalances
become more widespread, as it is driven by widespread risk-taking behavior, more monetary policy
adjustments need to be considered rather than relying solely on a more targeted set of steps. This
is because of monetary policy in general affecting asset returns and borrowing costs and less
vulnerable to circumvention. On the other hand, the use of a variety of other measures in large
scale can cause distortion and large administrative costs. Third, the widespread effects of monetary
policy are less alarming if costs to growth and inflation are low in the near term and are overcome
by the possible benefits to future growth and inflation. This balance tends to become smaller when
the business cycle is in line with the financial cycle.

This approach is reflected in the Bank's response to the possible emergence of financial imbalances
in recent years. After lowering the Overnight Policy Rate (OPR) to the lowest level ever recorded

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at 2.00% during the financial crisis in the advanced economies in 2008-2009, the Bank has
gradually reduced this extraordinary level of monetary base, by raising the OPR by 100 basis points
to 3.00% between March 2010 and May 2011. The Bank recognizes that maintaining an OPR at
an extraordinary low level for a long time could trigger a widespread financial imbalance.

Moreover, asset prices and credit growth also recovered quite strongly following continued capital
inflows following highly accommodative monetary policy stance among advanced economies.
Consequently, by taking advantage of the opportunities that existed, the OPR was restored to a
reasonable level when domestic economic growth was assessed as stronger. However, at the same
time, higher interest rates are realized to attract more capital inflows, which may make it difficult
to avoid unemployment happen.

In this regard, the Bank's various policy instruments, which include sterilized intention under the
flexible exchange rate regime, and the Statutory Reserve Requirement (SRR), have played an
important role in complementing monetary policy. The Comprehensive set of measures to address
the unemployment/financial imbalances reflects the overall policy philosophy of the Bank that
provides consideration to all existing policy tools and considers the most effective combination to
address the issues being faced. Such an approach is required following interactions within and
between the financial system and the increasingly complex economy.

5.0 STRATEGY ECONOMY GROWTH

5.1 Encourage Private Investment.

To ensure that the country's high growth potential is achievable, the private sector needs to play a
role again as a driver of economic growth. In this regard, the private sector needs to increase
existing investments, as well as explore new investment opportunities.

Hence, immediate action needs to be taken to provide a more attractive and conducive investment
climate to encourage private investment initiatives. For this purpose, the following steps will be
implemented:

i. making Small and Medium Enterprises (SME) a catalyst for growth; and

ii. loosen the Foreign Investment Committee Guidelines (FIC).

Make SME a catalyst for growth

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5.2 Strengthening the Competitiveness Of The Country.

In an effort to improve the country's competitiveness, existing tax incentives are further improved
in line with the recommendation by the Cabinet Committee on the Promotion of National
Competitiveness chaired by YAB Deputy Prime Minister, as follows:

i. Extend the Period of Pioneer Status and Investment Tax Allowance under pre-package
scheme.

Under the pre-package incentive scheme, Pioneer Status with full tax exemption for 10 years or
100 percent Investment Tax Allowance for 5 years is given on a case-by-case basis.

5.3 Building New Sources of Growth.

As an open economy, the country is exposed to uncertain external environment. Therefore, the
country needs to reduce the excessive dependence on the external sector. Meanwhile, initiatives
need to be enhanced to mobilize internal-driven economic activities. For this reason, the state
should diversify the roots of new growth. The main sectors to be given particular attention are the
services, construction, manufacturing and agriculture sectors.

5.4 Improve Delivery System Effectiveness.

Efficient public service delivery system is required to ensure smooth and effective implementation
of national development policies and strategies. For this, the Government has agreed with the
recommendation of the Strategic Thrust Committee to Enhance Government Service Delivery
chaired by the Chief Secretary to the Government. Support and facilitate investments in the
manufacturing sector proactively, whereby the Malaysian Industrial Development Authority
(MIDA) will appoint project officers, specifically for hand-hold and assist investors to obtain all
the necessary approvals for a project until the project is ready to operate.

5.5 Ensuring Balanced, Inclusive and Sustainable Economic Growth.

Actively promoting import-substitution or import-substitution services such as shipping, port,

education and professional services. This, in order to reduce dependency on external resources for
procurement of goods and services. Iintensify the promotion of the purchase of Made in Malaysia;

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6.0 Conclusion

To maintain growth and competitiveness to face the development of globalization and

liberalization. Macroeconomic prudential management to ensure optimum and efficient use of
resources as well as strengthening the resilience of the financial system is needed to sustain growth.
Strategies for addressing key challenges during the Plan period include enhancing productivity,
enhancing quality human resource offerings, intensifying R & D activities and improving the
development of sectors that contribute to growth. To enable the State to develop a knowledge-
based economy, the national economy should operate at higher production boundaries and
accelerate the transition from input-driven growth to productivity-driven growth. At the same time,
focus will also be given to improve the quality of life through the provision of better social services
including education and health facilities, adequate and affordable housing and other related
services. Efforts will also be undertaken to ensure social life of society is reinforced and has the
resilience to face negative influences that may impact on the basic tolerance and social harmony
as well as nation building.

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Federal Reserve Bank of New York Staff Reports.

Bank Negara kekalkan OPR pada 3.25 peratus. (2016, May 19). Retrieved November 04,
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Borio, C. E., & Zhu, H. (2008). Capital regulation, risk-taking and monetary policy: a
missing link in the transmission mechanism? Basel: BIS.

Borio, C. E., Drehmann, M., & Tsatsaronis, K. (2012). Stress-testing macro stress
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Dasar Monetari Pada Tahun 2014 - bnm.gov.my. (n.d.).

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Loh, J. S. (2017, June 01). Malaysia’s monetary, fiscal policy in current economic
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http://www.bnm.gov.my/index.php?ch=en_press&pg=en_press&ac=4506&lang=en
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Nee, E. A. (2014, March 18). How OPR hike will affect borrowers. Retrieved November
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