Taylor's University ECN60204 Macroeconomics: Monetary Policy Report

This report provides a comprehensive analysis of Malaysia's monetary policy, specifically focusing on the Bank Negara Malaysia's (BNM) decision to cut the Overnight Policy Rate (OPR) to stimulate economic growth. The report begins with an introduction to the issue of slow economic growth and the rationale behind the monetary policy intervention. It then delves into an economic analysis, utilizing the aggregate supply and aggregate demand model to illustrate the effects of the OPR cut on investment, consumption, and overall economic output. The analysis explains how the reduction in the OPR leads to increased money supply, lower lending rates, and subsequently, increased investment and demand. This, in turn, shifts the aggregate demand curve, leading to a higher equilibrium level of output and price, ultimately pushing the economy towards full employment. The report concludes by summarizing the effectiveness of the expansionary monetary policy in boosting the economy and suggests that while the OPR cut is a significant step, other policies like direct money infusion by buying back bonds could also be considered. Figures illustrating the mechanisms of the policy are included in the appendix, along with a list of cited references.

Running head: MACROECONOMICS
Macroeconomics
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Table of Contents
Article.........................................................................................................................................2
Analysis......................................................................................................................................2
Introduction............................................................................................................................2
Economic analysis..................................................................................................................2
Conclusion..............................................................................................................................4
References..................................................................................................................................5
Appendix....................................................................................................................................6

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Article
https://www.reuters.com/article/malaysia-economy-rates/update-2-malaysia-c-bank-makes-
1st-rate-cut-since-2016-in-bid-to-lift-growth-idUSL3N22J16A
Analysis
Introduction
The article focuses on the monetary policy to boost the slow economic growth of
Malaysia. The slow economic growth means that the economy will operate at a lower
economic equilibrium than the desirable and full employment level output in the long run.
The monetary policy that the Bank Negara Malaysia used is the cut in Overnight Policy Rate
(OPR) to boost the economic growth rate by pushing the consumption demand up. The
consumption increases due to the induced effect exerted by the increase in the investment. To
discuss this, we thus use the theory of monetary policy and aggregate supply and aggregate
demand model.
Economic analysis
As per the article, the Malaysian economy is facing sluggish economic growth, which
is negatively affecting the overall economy. In the long run, slow down in economic growth
will reduce the total output of the economy due to negative future assumption regarding the
increase in income. Thus, stagnation in economic growth will not increase employment, and
the businesses will be sluggish (Coates 2014). The economy will operate in the lower output
level than the full employment output level. The equilibrium level is given by the equilibrium
of price P1 and quantity Q1 as show in figure 3 in appendix. The desirable long run
equilibrium is also given in figure 3 and shown as red dot and is the full employment level of
output without any recessionary or inflationary gap. The slowing down of the economy has
caused due to several reasons; one of them as stated in the article, is the weak export sector.

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The prolonged period of slow economic growth should be encountered with policies that pull
the Malaysian economy from the low economic equilibrium. To increase the economic
output, it is necessary that the demand for the product rise. Without sufficient increase in the
demand, supply would not increase, and there will be low employment, low income and low
economic equilibrium (Agénor and Canuto 2015). Thus, it is necessary for the government
of Malaysia to formulate effective policies such that the disposable income of the consumers
increase and thereby demand increase. Both fiscal and monetary policies can do this;
however, in this article, monetary policy has been used. The policy used in the article is
expansionary monetary policy to increase the economic output and thereby increase
economic growth (Kaplan, Moll and Violante 2018). The BNM has reduced the overnight
policy rate (OPR) by 25 basis points to 3.00. It will increase the commercial banks’ lending
and thereby increase the money supply in the economy. With induced effect, investments
increase and thus output and employment increases (Keynes 2018). The income of
individuals will also increase, and thus demand will increase and thereby, both price level,
and economic output increases and the economy of Malaysia reaches a higher and desirable
equilibrium, which is at full employment output level (Johnson 2017). The mechanism of the
policy is shown in figures 1, 2 and 3 given in the appendix. In figure 1, it can be seen that due
to cut in interest or overnight policy rate from r to r* the money supply curve shifted
rightward from MS to MS1 and a new equilibrium occurred at the intersection point between
MS1 and MD. Hence, due to cut in interest rate there is a rise in money supply from m to m*.
The effect on the economy due rise in money supply can be seen in figure 2. Decline in bank
lending interest from i to i* increases the investment from I to I*. It has caused the
borrowings from the business to increase and thus with increased investment, employment
increases and income of individuals increases and thereby demand in the economy increases
(Khan and Sattar 2014). This change in demand shifted the aggregate demand curve from

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AD1 to AD2 in figure 3. With induced effect, price level increases from P1 to P2 and
quantity increases from Q1 to Q2. The economy thus operates in full employment level of
output (given by LRAS), which is the desirable long run equilibrium.
Conclusion
It can be summarized from the discussion above that an expansionary monetary policy
has been used by the BNM to boost the economy of the country. The policy used in this case
is cut in interest rate (OPR in Malaysia). The effect of the cut in OPR rate has been quite
effective as it successfully boosted the economy by increasing the investment and thereby
increasing employment, demand and output to the level of full employment. However, in the
long run, the effect of the OPR cut can be seen prominently. The other policy that might
have directly increase the demand is the infusion of money by buying back bonds from the
economy.

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References
Agénor, P.R. and Canuto, O., 2015. Middle-income growth traps. Research in
Economics, 69(4), pp.641-660.
Coates, D., 2014. Models of Capitalism: Growth and stagnation in the modern era. John
Wiley & Sons.
Johnson, H.G., 2017. Macroeconomics and monetary theory. Routledge.
Kaplan, G., Moll, B. and Violante, G.L., 2018. Monetary policy according to
HANK. American Economic Review, 108(3), pp.697-743.
Keynes, J.M., 2018. The General Theory of the Rate of Interest. In The General Theory of
Employment, Interest, and Money (pp. 145-153). Palgrave Macmillan, Cham.
Khan, W.A. and Sattar, A., 2014. Impact of interest rate changes on the profitability of four
major commercial banks in Pakistan. International journal of accounting and financial
reporting, 4(1), p.142.

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Appendix
Figure 1: Reduction in OPR and the increase in the money supply
Source: (Created by the Author)

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Figure 2: Decrease in bank lending interest rate and increase in investment
Source: (Created by the Author)

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Figure 3: Increase in
demand and improved economic equilibrium with economic growth
Source: (Created by the Author)