Economic Policy Instruments

The government uses economic policy instruments to achieve goals such as economic growth, stable prices and full employment. The two main instruments are fiscal policy and monetary policy. Both are used to tackle problems such as inflation and unemployment. The basic difference is who carries them out: fiscal policy is run by the government, while monetary policy is run by the central bank, Bank Negara Malaysia.

Fiscal policy

Fiscal policy is the use of government spending and taxation to influence the economy. It is carried out by the government through the annual Budget (Belanjawan) tabled in Parliament. When the economy is sluggish and unemployment is high, the government can increase spending and cut taxes (expansionary fiscal policy) to stimulate demand. When inflation is high, the government can reduce spending and raise taxes (contractionary fiscal policy) to cool the economy.

Monetary policy

Monetary policy is the control of the money supply and interest rates in the economy. In Malaysia it is carried out by Bank Negara Malaysia, the country's central bank. Its main tool is the Overnight Policy Rate (OPR). Raising the OPR makes borrowing more expensive, reduces spending and helps control inflation. Lowering the OPR makes borrowing cheaper, encourages spending and investment, and helps reduce unemployment. Besides the OPR, Bank Negara Malaysia can also change the money supply by selling or buying government securities; selling securities withdraws money from the economy, while buying them adds money into circulation.

In short, inflation is fought with a contractionary stance that reduces total spending in the economy, while unemployment is fought with an expansionary stance that raises spending. The government and Bank Negara Malaysia must balance these two goals, because measures that fight inflation can sometimes slow growth and raise unemployment.