Revisiting effectiveness of interest rate as a tool to control inflation: evidence from Malaysia based on ARDL and NARDL

Public policy remains a paradox and a challenging pursuit in finding a delicate balance between conflicting economic goals and outcomes. Nevertheless, interest rate is a commonly used monetary policy tool to maintain a low and stable inflation. However, the effectiveness of interest rate in controlling inflation remains unanswered conclusively. Undertaking a wrong policy stance will lead to huge costs to the economy and society as a whole. Therefore, the purpose of this study is to investigate the lead-lag relationship between inflation and interest rate, and whether the relationship between the two variables is linear. These will determine whether interest rate is an effective tool in the context of Malaysia. This study extends prior literature by using a more recent monthly time series data and advanced techniques known as NARDL and ARDL. Based on this study, it is found that inflation rate is the most exogenous variable while interest rate is the most endogenous variable, hence policy makers have no influence over inflation. A crucial policy implication is policy makers should not use interest rate to control inflation but instead, they should focus on supply side policies to manage inflation