MBSA1523 Managerial Economic and Policy Analysis

SEMESTER II SESSION 2022/2023

Section [01]

TITLE: Impact of OPR on Domestic Business Activities – Labour Market

NAME MATRIC NO. PHOTO

HO JING YI MBS221190

Submission Date : 18th May 2023

Presentation Date: -
TABLE OF CONTENTS

1.0 INTRODUCTION TO OVERNIGHT POLICY RATE 1

2.0 ROLE OF OVERNIGHT POLICY RATE 1

3.0 EFFECTS OF OVERNIGHT POLICY RATE ON LABOUR MARKET 2

4.0 CONCLUSION 4

Reference 5
1.0 INTRODUCTION TO OVERNIGHT POLICY RATE

The overnight policy rate (OPR) is the interest rate set by the central bank of a country at
which the commercial banks can borrow or lend overnight funds to each other. It is used as a
benchmark for other interest rates in the economy, making it a key tool for monetary policy.
The central bank lends or borrows funds with a maturity of one day to or from commercial
banks and other financial institutions. According to Bank Negara Malaysia, it is a key tool
used to control inflation and stabilize currency exchange rates. The amount of cash in a bank
fluctuates daily based on the amount of deposits and withdrawals made. Banks only take out
loans from other financial institutions when cash outflows are more than their reserve balance
(Ri, 2019). For example, if most people take out their money to buy Coldplay tickets on the
same day, the bank will have to make borrowings from another commercial bank or the
central bank to maintain appropriate statutory reserve requirements.

2.0 ROLE OF OVERNIGHT POLICY RATE

The OPR serves as a benchmark for other interest rates in the economy. Many lending rates,
such as mortgage rates, corporate loan rates, and credit card rates, are often tied to the OPR.
Movements in the OPR directly impact these rates, affecting borrowing costs for businesses
and individuals. It affects borrowing costs for both businesses and individuals. It allows
central banks to influence short-term interest rates in the economy. By adjusting the OPR,
central banks can influence borrowing costs, liquidity levels, and the availability of credit,
which, in turn, affect economic activities such as consumption, investment, and borrowing.

OPR is essential for promoting economic stability and regulating inflation. Keeping
prices stable and reining in inflation is one of the main goals of central banks. The OPR is an
essential instrument to achieve this goal. By raising or lowering the OPR, central banks can
affect borrowing costs for banks, which can influence consumer and business spending and,
consequently, aggregate demand. Adjustments in the OPR are used to manage inflationary
pressures and ensure price stability. By setting an appropriate level for the OPR, central banks
can stimulate or moderate economic activity, depending on the economic conditions.
Lowering the OPR can encourage borrowing and investment, stimulating economic growth,
while raising the OPR can cool down an overheating economy and prevent excessive
borrowing and inflationary pressures.

Besides that, the OPR also serves as a tool to maintain stability within the financial
system. By setting the OPR, central banks can influence the cost and availability of funds for
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banks and financial institutions. This helps regulate the overall liquidity in the banking
system, ensuring smooth functioning and mitigating risks (Bank Negara Malaysia, 2020).

3.0 EFFECTS OF OVERNIGHT POLICY RATE ON LABOUR MARKET

Overnight policy rates impact the labour market through their influence on economic
conditions, including the rate of GDP growth, unemployment, and the cost of goods and
services.

Figure 1: Effect of OPR on Investment Demand

Figure 2: Effects of OPR on Output

Based on Figure 1, the horizontal axis represents investment, while the vertical axis
represents interest rates. The investment demand curve slopes downward, indicating the
negative relationship between interest rates and investment spending. Based on Figure 2, the
horizontal axis represents Real GDP or output, while the vertical axis represents the price

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level. The aggregate demand (AD) curve slopes downward, indicating the negative
relationship between the price level and the level of output. The original AD curve (AD0)
intersects the short run aggregate supply (AS) curve at a point (E0) representing the
equilibrium level of output and employment.

If the central bank decides to control the high inflation, they will decide to raise the
OPR. This will influence the short-term borrowing costs for individual businesses, finance
companies and banks. Bank rates will increase, in other words, borrowing costs increase,
leading to higher interest rates.

Based on Figure 1, the interest rate will increase from r0 to r1. This can reduce
investment spending as businesses may be less willing to undertake new projects or expand
their operations. The investment demand curve will shift leftward from I0 to I1, indicating a
decrease in investment. This can reduce investment spending and consumption, which can
decrease aggregate demand. Based on Figure 2, the AD0 curve shifts leftward to AD1. The
new equilibrium (E1) occurs at a lower level of output and employment.

OPR produces a contractionary effect on the labour market. by making it more

expensive to borrow money and thereby restricting demand for consumer goods and services
(Phelps, 1994). This implies that the higher rates on credit cards may result in lower rates on
deposits. When commercial banks have to pay more for the money they borrow from central
banks, they will be less likely to lend money to individual businesses who would have
otherwise obtained it through loans. This could lead to fewer business opportunities and
slower economic growth. This reduced liquidity can lead to job losses as companies reduce
production or eliminate positions due to lower demand. Reduced consumer spending can also
further weaken labour conditions by decreasing wages as businesses struggle to remain
profitable. Hence, increased OPR raises interest rates which leads to higher unemployment
and lower employment, ceteris paribus (Feldmann, 2013).

Alternatively, decreases in OPR can have an expansionary effect on the labour

market. When the overnight rate is lowered, it makes it cheaper for businesses to borrow
money, which can lead to increased consumer spending and a higher demand for consumer
goods and services, thus leading to increased hiring and wages. This increased liquidity also
means employers will have more funds available for hiring new employees or giving raises to
existing workers, leading to improved employment outcomes.

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4.0 CONCLUSION

Overall, changes in OPR have a significant impact on the labour market through their effects
on interest rates and access to credit. Increases in OPR are often contractionary in nature,
while decreases are more often expansionary. As such, it is important for governments and
central banks that control these rates to consider their potential implications when making
decisions about monetary policy.

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Reference

Bank Negara Malaysia, "Overnight Policy Rate (OPR),"

https://www.bnm.gov.my/index.php?ch=en_financial_markets&pg=en_financial_mar
kets_opr&ac=1
Ri, Tsumaki. (2019). Explaining and justify why would BNM Increase the OPR.
10.13140/RG.2.2.36691.84009.
Feldmann, H. (2013). Real Interest Rate and Labor Market Performance around the World.
Southern Economic Journal, 79(3), 659–679.
Phelps, E. S. (1994). Structural slumps: The modern equilibrium theory of unemployment,
interest, and assets. Harvard University Press.