PETALING JAYA: Since inflation is also driven by factors beyond demand, relying on monetary policy alone is not sufficient to address rising prices.
More specifically, monetary policy alone cannot tackle challenges arising from supply shocks or changes in regulation that often lead to a higher cost of production and eventually, higher prices to consumers.
In addition to that, monetary policy takes effect with a lag.
According to Bank Negara’s estimates, an interest rate increase can take up to two years to fully affect inflation.
The outcome depends on several factors, including how fast banks adjust their deposit and lending rates, to what extent consumers and businesses change their spending and whether demand weakens enough to slow down price increases.
“This delay means prices might continue rising for a while before stabilising, making it hard to limit increases in households’ cost of living,” the central bank said in its 2024 annual report.
“Therefore, addressing inflation would require other complementary policy tools to influence prices borne by households, especially those affected by supply factors,” it added.
Unlike monetary policy, a blunt tool, fiscal policy can be more targeted to ease living costs for specific groups.
“For example, the government can help to manage these rising expenses by providing targeted subsidies or tax breaks to households.
“Furthermore, when supply disruptions from events such as adverse weather cause general prices to increase, the government can give cash assistance to affected households to supplement their income,” it said.
Alternatively, financial assistance or subsidies can help businesses cope with higher production costs from supply shocks, reducing cost pass-through and limiting price increases for consumers.
However, this would, in turn, increase the fiscal burden and limit investments in critical areas such as health, education and infrastructure.
“Therefore, this approach should be done judiciously and as a temporary measure as it only addresses the symptoms rather than the root cause of cost of living concerns.
“Fiscal policy also plays a role in raising the economy’s productive capacity,” it noted.
The government can encourage this by, for example, investing in infrastructure, offering favourable tax policies for specific sectors like high-growth-high-value industries and promoting research and development initiatives.
This would make the economy more competitive and efficient, allowing businesses to expand production at lower costs.
Eventually, this can translate to a more moderate pace of inflation.
Among the factors that cause high inflation are demand shocks – when there is a sharp increase in demand for goods and services in the economy; supply shocks – sudden disruptions reducing the availability of goods and services in the economy; and regulatory changes such as new taxes, tariffs or requirements to comply to stricter environmental policies which can in turn increase production costs.
