As of late November 2022, interest rates in Indonesia, Malaysia, Thailand, and the Philippines generally remain too low to harness inflation and reverse their respective currency’s decline against the US dollar. Application of the Taylor Rule suggests Indonesia’s current policy rate is nearest to its prescribed level, while the policy rates in Malaysia, Thailand, and the Philippines each remain more than two percent below their prescribed levels.
- The Taylor Rule, introduced by John Taylor in 1993, seeks to identify the prescribed value of the federal funds rate—the Federal Open Market Committee’s short-term interest rate target—based on the values of inflation and the excess of actual GDP over potential GDP, also known as the output gap.[1] The equation, identified below, predicts the federal funds rate to be 2% when inflation is at its target rate and output is at potential.
r = p + 0.5y + 0.5(p – 2%) + 2%,[2],[3] where:
r = policy rate
p = expected inflation
y = output gap
2% = targeted inflation rate
- Based on our inputs to the Taylor Rule, we find the prescribed policy rate in Indonesia to be 5.61%; in Malaysia, 4.96%; in Thailand, 4.71%; in the Philippines, 7.74%; and, for comparison, in the US, 5.12%.
Prescribed Policy Rate from Taylor Rule and Current Rate[4]
- Our inflation input reflects each country’s central bank’s inflation estimate for 2023. We estimate the output gap based on the IMF’s 2023 GDP forecast less the average annual GDP growth rate from 1990-2018. The table below provides a summary of the inputs we apply to the Taylor Rule.
Inputs for Taylor Rule Estimates
| Inflation | 2023 GDP Forecast[5] | Potential GDP[6] | Output Gap | r | Current rate | Difference | |
| Indonesia | 3.00%[7] | 5.00% | 4.79% | 0.21% | 5.61% | 5.25%[8] | 0.36% |
| Malaysia | 3.05%[9] | 4.40% | 5.62% | -1.22% | 4.96% | 2.75%[10] | 2.21% |
| Thailand | 2.60%[11] | 3.70% | 4.09% | -0.39% | 4.71% | 1.00%[12] | 3.71% |
| Philippines | 4.30%[13] | 5.00% | 4.61% | 0.39% | 7.64% | 5.00%[14] | 2.64% |
| USA | 3.24%[15] | 1.00% | 2.47% | -1.47% | 5.12% | 4.00%[16] | 1.12% |
The Taylor Rule’s implication for Indonesia—underscored by Indonesia’s central bank governor Perry Warjiyo stating the bank would not be as aggressive as the US Federal Reserve[17]—could help explain why the rupiah has underperformed recently when compared to the ringgit, baht, and peso. As its policy rate reaches its prescribed level, Bank Indonesia will be less likely to raise rates, which comes at a time when the Fed, as well as other Southeast Asian central banks, continue to signal additional rate increases;[18] typically, a higher interest rate attracts foreign investors, creating demand for the currency.
- Indonesia’s rupiah for most of 2022 outperformed the ringgit, baht, and peso relative to the US dollar, but in November its weakness continued while its rival currencies strengthened. The Taylor Rule suggests Malaysia, Thailand, and the Philippines are more than two percentage points below their prescribed policy rate, and thus will require continued rate hikes.
Performance of IDR, MYR, THB, and PHP to USD, Year-to-Date through 18 November 2022
- Similar to its performance against the USD, the rupiah for most of the year outperformed the ringgit, baht, and peso against a currency basket of primary trade partners. After reaching its peak of 106.53 in late September, however, the rupiah has declined 6% to 100.18 as of 18 November.[19]
Performance of IDR, MYR, THB, and PHP Relative to Currency Basket of Trade Partners, Year-to-Date through 18 November 2022
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[1] Federal Reserve Bank of Atlanta. “Taylor Rule Utility.” Updated 10 November 2022.
[2] Ben S. Bernanke. Brookings. “The Taylor Rule: A benchmark for monetary policy.” 28 April 2015.
[3] John B. Taylor. Carnegie-Rochester Conference Series on Public Policy 39 (1993) 195-214 North Holland. “Discretion versus policy rules in practice.” 1993.
[4] The Bank of Thailand meets on 30 November, where we expect it will raise its policy rate 25 basis points to 1.25%.
[5] IMF. “World Economic Outlook: Countering the Cost-of-Living Crisis.” October 2022.
[6] Potential GDP reflects the average annual GDP growth rate from 1990-2018. GDP data is in constant 2017 international US dollars and is sourced from the World Bank. Based on the same data, potential GDP based on the Labour Productivity Growth Accounting Equation yields the following rates: Indonesia 4.72%, Malaysia 5.59%, Philippines 4.51%, Thailand 4.15%, and USA 2.47%.
[7] Bank Indonesia. “Inflation Target.” Accessed on 18 November 2022.
[8] Bank Indonesia. “BI 7-day reverse repo rate raised 50bps to 5.25%; synergy maintaining stability and recovery momentum.” 17 November 2022.
[9] The Edge Markets. “Inflation seen at 3.3% in 2022, 2.8%-3.3% in 2023.” 7 October 2022.
[10] Bank Negara Malaysia. “Monetary Policy Statement.” 3 November 2022.
[11] Bank of Thailand. “Monetary Policy Committee’s Decision 5/2022.” 28 September 2022.
[12] Bank of Thailand. “Monetary Policy Committee’s Decision 5/2022.” 28 September 2022.
[13] Bangko Sentral ng Pilipinas. “Monetary Board Raises Policy Rate by 75 Basis Points.” 17 November 2022.
[14] Bangko Sentral ng Pilipinas. “Monetary Board Raises Policy Rate by 75 Basis Points.” 17 November 2022.
[15] FRED. “1-Year Expected Inflation.” 14 November 2022.
[16] FRED. “Federal Funds Target Range – Upper Limit.” 17 November 2022.
[17] Reuters. “Indonesia c. bank: do not expect aggressive rate hikes like Fed.” 7 September 2022.
[18] Karen Lema. Reuters. “Philippine c. bank has to raise rates along with Fed to support peso – governor.” 17 November 2022.
[19] Malacca Research index based on performance of regional currencies against a currency basket of trade partners.
[20] A positive value indicates the local policy rate exceeds the US policy rate. A negative value indicates the local policy rate is less than the US rate.