Malaysia adopted inflation anchoring over inflation targeting…

Interesting speech by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia.

He says despite strong preferences to adopt inflation targeting before 2008, the central bank did not straightjacket itself. They had a broader role with focus on inflation anchoring and not targeting. This way they avoided groupthink as well:

The theoretical elegance of inflation targeting appealed to many central banks to tread on the same path. In Malaysia we had considered this approach but decided to forge our own route.

While the broad framework was appealing, we concluded that adopting an explicit inflation target would have the unintended effect of ‘straitjacketing’ our policy flexibility. We believed that the inflation targeting framework was not ideal for an open and small economy with a sizeable financial market like Malaysia.

An economy such as ours is susceptible to real external shocks and could also face problems such as large and volatile capital flows and exchange rates. Therefore, we did not adopt the inflation targeting framework. We adopted what we characterised as ‘inflation anchoring’. The policy outcome is similar, stable inflation. But the process and focus are different. There are several reasons for this approach.

First, we did not believe in confining ourselves to a single overarching target for price stability, especially not when the economy is complex and consists of many moving parts. We wanted to avoid a situation where too much focus on achieving a single target could lead to potential blind spots. In particular, we did not want our monetary policy to be driven predominantly by movements in one single price indicator, to an extent that we ignore other important risks such as asset price bubbles and the destabilising unwinding of these assets.

Second, our experience showed that Malaysia’s episodes of high inflation are typically externally driven, such as through global oil prices. In fact, inflationary episodes in Malaysia have rarely been a monetary phenomenon.


Third, as an open economy with flexible exchange rates, Malaysia is prone to large and volatile swings of capital flows which can lead to exchange rate overshooting. In fact, we just recovered from what was one of the sharpest ringgit depreciation periods since the Asian Financial Crisis. I am sure that this is still fresh in everyone’s mind. We recognised much earlier on that the inflation targeting framework is not well-suited to our domestic conditions as it can compound the risks of unfettered capital flows. Instead, we believed that destabilising capital flows need to be effectively managed to ensure orderly domestic conditions. It did not help that some economies even hosted illegal NDF activities that had grave spillover implications on neighbouring economies. The fact that multilateral institutions are oblivious to these damaging consequences to some of their member countries is very disquieting.

A further point is the dangers that can arise when inflation targeting inappropriately shifts the burden onto monetary policy to solve problems that in reality, require much broader policy responses on the fiscal side. When much needed actions are postponed, it has important consequences for our long term growth potential.

He points how in 2007-08, when inflation rose due to global oil prices, the central bank  did not raise policy rates. Their view was this was temporary shock and would not lead to higher inflation expectations.

He further adds how their stand over inflation targeting has been proved right as post-crisis it has been under scrutiny.

Interesting stuff. We hardly care and follow central bank policies differ across the world especially from smaller countries.


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