Where Does Money Supply, Interest Rates and Inflation Intersect?

Money supply is influenced by supply and demand actions of the central bank and commercial banks. In this context, it is interesting to examine narrow (M1) measure of money supply (currency in circulation and demand deposits) with M3, the broader measure of money supply and its impact on GDP, inflation and the changes in OPR (overnight policy rate).

The above chart (with data from 2012 to 2021) shows growth of M1, M2, GDP, inflation and OPR. In general, M1 has been ranging between 4-6% with exceptions in 2012 (13.1%), 2017 (11%), 2020 (15.7%) and 2021 (10.4%). M3 has not shown wide divergences as M1. Printing money has been where we needed to reflate the economy. In the context of the above, we have a lagged effect of a year or so, especially in 2020 and 2021 primarily because of the MCO. There were several Penjana/stimulus packages (because of the MCO) and these were supposed to reflate the economy. Money supply and interest rates have an inverse relationship. A larger money supply lowers interest rates.

In the second chart, we are doing a cursory look at CPI (transportation), CPI (Food), deposit rates and OPR. The line on CPI (transportation) seems amplified with sharp swings with GDP. If GDP is subdued, then transport cost tanks, example in 2020 in the midst of Covid-19. And when the economy is on a recovery mode, transport cost goes up, 2021 or 2017. The CPI (food and non-alcoholic beverages) impacts the B40 group. And there are cases where it exceeds deposit rates (2013 to 2017 and in 2021). That is negative interest rate and savers are penalised. That again impacts our exchange rate. 

Not shown above is the velocity of money circulation (nominal GDP to M1).  Traditionally, it is viewed as a constant. Prior to 2020, this has been in the range of 3.11 to 3.39 (for 2012 to 2019). In 2020 and 2021, this declined to 2.71 and 2.62 respectively. What does this mean? Subdued economic activity owing to the MCO has impacted the number of times money changes hand (velocity). It may recover in 2022.

BNM has greater ability and data to monitor the issue of growth, interest rate, exchange rate. Hopefully, they have the wisdom and courage to act ahead of the curve! And so do anticipate more upward revision of the OPR.

References:

Where inflation and interest rates intersect, Heather McArdle, S&P Dow Jones Indices

BNM Annual Reports

The Malaysian Economy in Figures, EPU

Trading Economics (www.tradingeconomics.com)