Muhammad bin Ibrahim: Public policy perspective - some thoughts
and contemplations from a central banker
Remarks by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia (Bank Negara
Malaysia), at the 40th Harvard Business School Alumni Club Malaysia Anniversary Dinner, Kuala
Lumpur, 9 February 2018.
* * *
Thank you for the invitation to speak tonight, among such impressive luminaries. I would like to
take this opportunity to share, reflect and learn from past experiences. Since my line of work
relates to public policy, I would like to approach it from this perspective.
The remarkable paradox of public policy
Public policy has never been easy. It is deceivingly simple if we just think about the outcomes.
For example, the country needs more public healthcare; or prices of goods need to be lower; or
people should have more access to credit. In practice, the policymaker makes difficult decisions
involving complicated trade-offs, competing objectives and priorities. Resources are limited and
invariably, any allocation made will affect many persons in different ways. Public policy can never
ever meet the needs of everyone all at the same time.
Given these challenges, it stands to reason that there can be no set template or rules when it
comes to executing public policies. From this perspective, it is therefore a remarkable paradox
that policymaking at the international level is steeped in conventions, rules and norms that set out
expectations on how policymakers should behave and conduct policies. These hard and soft
rules, have at times, guided policymakers through some turbulent episodes. Of concern however
is when this set of prescriptions act like a straitjacket, constraining policymakers from making
bold and necessary policy decisions, just because it does not conform to 'consensus thinking'.
This is in spite of universal acknowledgment that we are experiencing change that is unmatched,
both in pace and dimensions. Clearly this changes the rules of the game. Conformity could come
at a cost. And that cost can be significant if it is driven solely by ideology.
John F. Kennedy once said, "Conformity is the jailer of freedom and the enemy of growth". The
issue of conformity and how it affects social behavior has been the subject of study for decades.
It was in 1972 that Irving Janis, a psychologist at Yale and forerunner in the field of social
dynamics, first coined the term "group-think".
Professor Janis described this collective behaviour as "a mode of thinking that people engage in
when they are deeply involved in a cohesive in-group...when the members' strivings for
unanimity override their motivation to realistically appraise alternative courses of action". In other
words, group-think occurs when there is pressure to conform to an over-arching view or
strategy. As a result, members of the group often feel uncomfortable to deviate from the "norm",
leading to tunnel-vision and a fear to voice out opinions and come up with new ideas.
Sometimes, it can provide dubious cover for doing less than what is appropriate, and what is
needed.
To put this into perspective, consider the case of a large US automobile manufacturer. Often
cited in the fields of organisational ethics and industrial psychology, this case was seen as a
prime example of how conformity and group-think led to costly outcomes. In 2014, the motor
company was forced to recall nearly 30 million cars worldwide as faulty ignition switches were
found to have led to a loss of electrical power and sudden engine shutdown.
This malfunction also caused the airbags, power steering and power brakes to become
dysfunctional, risking the safety of drivers. As the scandal was uncovered, it was found to have
caused an estimated 124 deaths.
What is particularly harrowing, was the fact that this faulty ignition switch was known by the
company's employees for at least a decade before the recall. An independent probe
subsequently pointed to a corporate culture, which the then new CEO, described as "a pattern of
incompetence and neglect". Various case studies on the crisis highlighted that the tight financial
position in the early 2000s festered a corporate culture that was heavily focused on cost-cutting,
shaping employees' mindsets, conduct and ultimately values. Internal email transcripts revealed
that it would have cost an extra 90 cents per unit to modify the ignition switches. An internal
probe reported that the problem was misdiagnosed and dismissed as a "customer-satisfaction"
issue, rather than a safety problem. The company then advised their customers to remove heavy
objects attached to their car keys, such as bulky keychains, rather than fixing the root of the
problem itself. This story is not strange. It happens elsewhere as well.
In the world of central banking, serious risks can similarly arise from groupthink. There are many
rules governing policymaking that policymakers tend to follow rigidly, despite its waning
effectiveness. This increases the risks of being blindsided and promotes a culture that is
resistant to change.
An example of this in central banking is the 'inflation-targeting framework' which was considered
the international best practice in monetary policy framework for many years before the Great
Financial Crisis. My remarks are not a critique of the framework but rather, to highlight that there
are other approaches as well.
The premise behind the framework is very simple. It is also elegant. If the inflation trend deviates
beyond a central bank's expected target, typically around 2%, the central bank should use its
policy tools, namely the interest rate, to bring inflation back to target. Inflation targeting enables
monetary policy to focus on domestic variables and respond to external stimulus that impact
domestic price stability.
Since it was first adopted in 1989, it was seen as a simpler and more transparent policy
framework because it allowed the public to easily understand and observe the central bank's
motive, which is ultimately low and stable inflation. Within a short span of time, the popularity of
this new framework spread widely in both the advanced and emerging economies. It is quite
understandable. The framework is theoretically attractive, easily understood and simple to
communicate.
Deviating from the norm: Malaysia's approach
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.
That being said, external shocks that drive inflation do not require a monetary policy response if it
does not affect domestic demand or cause undue wage pressures.
I recall in 2008, that when global oil prices surged to a height of around USD140 per barrel and
Malaysia faced strong inflationary pressures that breached 7%, we were perceived as being
'behind the curve' for not raising interest rates. Under the inflation targeting framework, on the
other hand, logic dictates that in response to this period of supply-driven inflation, raising policy
rates by as much as 100 to 175 basis points in some countries were merited. The monetary
policy response is premised on the argument that anchoring inflation expectation supplanted
every other consideration including the source of inflationary pressures.
Allow me to illustrate how inflation expectations work. If you do not believe that the central bank's
monetary policy can bring inflation back down in say, two to three years' time, then inflation
expectations are considered unanchored. What this means is that if members of the public do
not believe in the central bank's ability to control inflation, a rise in prices could trigger public
expectations that prices will rise even more in the future.
Businesses will soon raise prices of goods, and workers, in facing higher prices, will in turn
demand for higher wages, leading to a vicious inflationary cycle. Inflationary expectations, if
unhinged, would eventually become a self-fulfilling prophecy. As such, the interest rate increase
reflects the central bank's strong commitment to control inflation. A central bank that is seen as
having a strong commitment and is credible in its actions to fighting inflation would therefore have
a higher probability of success in anchoring inflation expectations. This is essentially what we will
find in every textbook on monetary policy. In reality, however, there is more to inflation
expectations than meets the eye.
A case in point is Malaysia's inflation experience in 2008. At that time, we had the firm conviction
that the spike in inflation and inflation expectations during the period would be temporary, as the
prospect of weakening demand would dampen price increases in the future. Most importantly,
we also saw the sharp spike in commodity prices and increasing risks from the US financial
market which posed significant downside risk to future growth. As events began to unfold, this
conjecture turned out to be the baseline case.
When the Great Financial Crisis of 2007-08 erupted with both economic growth and financial
stability at stake, our decision not to raise interest rates was apt as it provided a much-needed
buffer. We moved from being 'behind the curve' to 'ahead of the curve' when other countries
began reversing their policies by cutting interest rates.
Fast forward to the current environment, inflation is becoming even more complex with the
influence of various factors such as globalisation, demographics and technology bearing on
inflation outcomes in ways we do not yet fully understand. Because of these external factors,
central banks in some economies have frequently missed their inflation targets over the past
decade. These central banks have had to work extra hard to anchor inflation expectations while
they continue to miss their targets. This has become a source of sizeable uncertainty and
volatility.
In Malaysia's case, keeping a broader view has suited our needs and has given us policy
flexibility to respond to economic and financial shocks, as we are not unduly straitjacketed into
meeting this explicit inflation target, which, under many circumstances, can prove to be very
elusive.
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.
Inflation targeting framework falling under heavy scrutiny
As it turns out, our choice of not conforming to the norm was not in vain. Inflation targeting is now
under scrutiny as its merits are debated widely. Many of these discussions centered on the
waning effectiveness of the framework and the need for additional policy instruments to make the
framework effective.
The sequence of events leading up to the Great Financial Crisis raised the argument that an
exclusive focus on achieving the inflation target could cause policymakers to overlook other
vulnerabilities, such as credit and asset price bubbles.
Delivering on inflation targets itself has also presented new challenges. Despite almost 10 years
of ultra-easy monetary policy, and despite stronger growth and better labour market conditions,
some countries are still devoid of inflation. This latest enigma of "missing inflation" has further
spurred the search for the next best thing after inflation targeting. It has become increasingly
clear that the nature of problems facing policymakers and the underlying heuristics are becoming
very complex. What we thought we knew about inflation dynamics has been inadequate and has
not factored in many other relevant factors. Inflation dynamics have evolved with structural
factors such as the global value chain, demographics, technological advancements and the
digitalisation of the economy.
In such a dynamic environment, it is only logical to think that one must be pragmatic, flexible and
agile. This is why we focused on inflation anchoring without being tied to a single numerical
target. To effectively do this, our monetary policy framework will take into account a broader
consideration of factors that could affect the domestic economy and financial system.
It also allowed us some flexibility to monitor how our monetary policy actions could interact with
key issues facing the public, such as distributional implications, cost of living, access to financing
and financial inclusion. As we understand these interactions better, our responses, including
monetary policy decisions, can be more nuanced and effective.
Malaysia's policy approach has remained relevant
Inflation anchoring was not the only thing we did differently. In fact, Malaysia has never shied
away from taking the path less travelled. This is not driven by any ideological design but we have
always been careful to ensure that policy prescriptions fit our economic, legal and operational
circumstances. Some of the policy approaches that have been our practice are only recently
being seriously considered by the global community. A good example is capital controls or now
more elegantly known as capital flow management measures. Our approaches, while
sometimes can be considered as 'different' are premised on several considerations.
First, is that we considered financial stability risks in our monetary policy decisions. While moves
to formalise this as part or within the broader context of monetary policy frameworks have been a
more recent phenomenon in the aftermath of the recent crisis, Malaysia has always been vigilant
against the risks of financial imbalances. We have looked into this aspect for as long as I can
remember. In 1992, for instance, the Bank had already introduced administrative limits, or macro
and microprudential measures as it is known now, to address the risks of financial imbalances
arising from specific sectors of the economy.
Back then, limits on hire purchase loans and guidelines on credit card operations were put in
place as complementary measures to the tighter monetary policy stance of the Bank. Even since
then, financial stability has remained an important mandate of the Bank. This mandate was
reinforced with the introduction of the Central Bank Act in 2009, which established Bank Negara
Malaysia as the financial stability authority for Malaysia.
Second, we have always kept our banking system supervisory role in-house, even when the
notion of separating the monetary authority from financial supervisory authority was held up as a
more effective model in more than a few countries. We now see moves to recombine these
functions under the central bank post-Great Financial Crisis. The UK, for instance, had restored
the supervisory role back to the central bank after a painful episode with the collapse of Northern
Rock in 2007. Authorities were widely blamed for inaction, poor coordination and constraints that
held back early interventions.
Third, is the fact that Malaysia has always relied on a broad policy toolkit, even during the early
1990s when we introduced measures to manage capital flows. It was only in 2012 that the IMF
updated their institutional view and began recognising the usefulness of capital flow management
measures.
More recently, at end-2016, we introduced bold 'market-correcting' and prudential measures to
ensure the orderly functioning of the domestic financial market. These measures were seen as
'anti-market forces' at its inception but they have been proven effective in reducing speculative
pressures on the ringgit and imbalances in the domestic foreign exchange market. It has in fact
further liberalised the market than the situation before the measures were implemented.
Learning from Malaysia's policy experience
There are important lessons behind Malaysia's approach which are relevant to our policymaking,
at least from my perspective. These lessons cut across profession and industry. It is not
exhaustive. But I would like to raise 5 points.
First, it is important for policymakers to remain agile in their approach to policies. We should not
be too rigid in our own ways that we neglect changes in the environment and fail to change with
the times. The world as we know it will be transformed with the rapid advancements in
technology and communication, big data and the list goes on. If we remain stagnant, we are
doomed to fail.
The willingness to renew and redirect policy is critical to successful policymaking. From the
outside looking in, the redirection of policy is often perceived to be regressive. In reality, they
reflect policies that aim to be more, rather than less, responsive to changing conditions. In the
same way that businesses expect governments to relax and adapt policy to capture new
opportunities, authorities have a professional duty to redirect policy, however unpopular, to
maintain stability and harness our collective growth potential when risks or unintended outcomes
become apparent. This requires much more confidence, boldness and courage.
Second, policymakers need to protect and value their autonomy in the conduct of policies and
not be constrained by prevailing rules and consensus thinking established by the international
community. International organisations have come up with various definitions and primers on
how they feel an economy should be managed. Their need for standardisation is understandable
because of the need to dispense consistent policy advice across many countries. However, that
being said, the domestic policymaker understands best the context of the local situation that the
country is facing. There should be no doubt in this.
Third, policymakers must not be afraid of instituting bold policies if they are deemed necessary.
This is especially important during times of stress or market failures that risk the orderly
functioning of the economy and financial system. Intervention in markets should not be a knee
jerk reaction. As a matter of principle, public policies should always first strive to facilitate a
selfregulating free market to correct itself. However, when markets fail, it is incumbent upon the
regulator to correct market failures. This ought to be the cardinal rule, especially for small and
open economies with sizeable financial markets. More often than not, corrective public policy can
be unpopular among the masses, but it is important to not lose sight of the bigger picture, for the
greater good. Often times, short-term pain is necessary for longer-term gains.
Fourth, clear and transparent communication is crucial. Policies will not be effective if the
motivations and understanding between policymakers and the public are not aligned. At the end
of 2016, the Bank actively sought out the feedback of industries and market participants that
were affected by the financial market development measures we introduced in November 2016.
This became an important source of information for us to continuously fine-tune the
implementation of the measures to help those affected to better adapt to the new environment.
Being transparent also means that policy intents should be quantified, measured and disclosed.
Finally, policymakers must not formulate public policy in isolation. We must promulgate policy
with hard facts, backed by statistics and sound theoretical evidence. Foremost, we should not
forget about the lives of people we are trying to help. A strong GDP growth figure will be less
meaningful if they do not create good quality jobs, better distribution of incomes and higher
standard of living for the people. Formulation of public policies must continue to be based on
sound economics and have the ultimate goal of improving the welfare of society.
While we remain cognisant of the broader distributional implications of our policies, issues that
are more structural in nature such as low productivity, income inequality and quality jobs creation
would also require specific policies that lie beyond the capacity of the central bank alone.
It requires collaboration across many domains, with other policy makers, and with many
stakeholders for the betterment of the standard of living and welfare of the general public.
As we know it, the world is fast evolving and we must keep pace. The progress of information
and communication technology, has been astounding and its assimilation into our economic and
financial system structure will be the catalyst to propel finance as the great social equaliser. But
for us to optimise the benefits for all, we need to strike the right balance between regulation and
allowing technological innovations to take place in our financial system.
Ultimately, regulations exist to promote a safe, efficient and sound financial system that is
competitive and where consumers' interest are protected. Regulatory regimes promote the
foundation of trust and confidence that is crucial in any financial system. If people do not trust the
system, financial intermediation cannot take place in any shape or form. As the modalities for
financial intermediation and payments are transformed by technology, regulation should play an
active role in creating a similar environment of trust to ensure overall financial stability.
The boundaries of regulation will evolve to provide the freedom for participants in the Malaysian
financial system to innovate and adopt technology to exploit efficiencies and create new and
better solutions. Solutions that not only deliver better experience for consumers, but that better
align the responsibilities that we all carry as responsible citizens, to lift people out of poverty,
provide our fellow Malaysians a decent living standard, eliminate discrimination and protect our
environment.
Regulation is never intended to make market players 'boring'. If they feel that way, it only tells us
one thing - that they have become too complacent in their comfort zone and should undertake a
reality check. Malaysia's financial institutions especially must not lay idle as innovations will be
relentless in accessing and penetrating the traditional market long enjoyed by the banks. Using
the disguise of being tied by regulations is not a valid excuse. We have raised this many times,
that the central bank will not hinder innovations in the banking system including those by
nonbanking institutions. So beware. Those bankers who are complacent and meek might experience
the rug being pulled from underneath them.
Conclusion
We hail from different backgrounds and experiences, but all of us here have the influence to
impact the Malaysian economy, no matter how big or small. We are duty-bound to play our roles
effectively and hold a bigger responsibility to ensure that nobody under our care is left behind as
we continue to progress.
On that note, I wish everyone a productive and fulfilling journey in 2018. To those who will be
celebrating Chinese New Year, I would like to extend my best wishes. Let us look forward to a
better Malaysia.
Thank you.