BIS central bankers’ speeches  3  •  At the same time, the global search for yield in a zero interest rate environment led to strong capital flows into the region, inducing increases in credit and asset prices. •  The business cycle and financial cycle began to diverge: raising interest rates to quell financial imbalances could potentially put the real economy at risk. Getting in all the cracks but not filling them A second reason why monetary policy may be ill-suited to address financial stability risks is that it is a blunt instrument. It may get into all of the cracks but some cracks may be just too big to fill. Financial vulnerabilities are often not evenly spread across the economy. They tend to be concentrated in specific sectors, such as in real estate. Monetary policy may be too blunt to address such specific risks and can cause significant collateral damage on the rest of the economy if it is calibrated to mitigate sector-specific risks. There is some empirical evidence that the cost-benefit trade-off in using monetary policy to lean against financial stability risks does not look promising. •  Kenneth Kuttner and Illhyock Shim estimate that a 100 basis point increase in the short-term interest rate would reduce real housing price growth by only 1 percentage point in the following quarter. •  Lars Svensson, drawing from the Swedish experience, finds that the cost of leaning against financial stability risks is high – with inflation too low and unemployment too high.
A central authority and a national repository can significantly improve the ability to better distribute, monitor and manage the supply-demand imbalances. Developing a thriving rental market should also be on the agenda to temper the nation’s fixation on home ownership. Another issue that banks should be concerned with is the sizable surplus in commercial property. In contrast to affordable housing, the office and retail markets are in oversupply. In 2016, the vacancy rate for prime office space in the Klang Valley stood at 21.8%, outstripping the regional average of 6.2%1. Monthly rentals of prime office space in Kuala Lumpur are the lowest among regional cities. Over the next few years, the significant incoming supply of large projects is likely to aggravate supply conditions in this segment. Signs of oversupply are also emerging in the retail segment in major urban centres in Malaysia. This can be traced to the abundance of shopping malls. You may be surprised to learn that there are as many as twenty shopping malls just along the 40km stretch of the LDP highway. It is equally astonishing that the prime retail space per capita in cities like Johor, Penang and Kuala Lumpur is actually higher than regional megacities such as Shanghai and Beijing, and also higher income cities such as Singapore and Hong Kong. A significant increase in vacancy rates, and the ensuing price corrections, are risks that the Bank has highlighted as far back as 2013.