What is meant by subprime mortgage crisis? Does it effect our Malaysia's economy?

Question:

What is meant by subprime mortgage crisis? Does it effect our Malaysia's economy?

What is meant by subprime mortgage crisis? Describe the causes and risks of subprime mortgage crisis to the various markets in your country. Which sectors of the economy were more severely affected? Which sectors were relatively unscathed?

· apply basic financial economic theory to explaining the workings of the domestic   and international financial systems

· demonstrate a working knowledge of the institutional framework for financing economic activity

· demonstrate an understanding of the operation of domestic money and capital markets and of their linkages with global financial markets

Analyse the effects of changes in the private financial system on economic activity.

Introduction

Sub prime mortgage crisis has made the total number of job losses in United States for year to date is more than 230,000.It has risen to more than five percent compare to year 2006. (AEP, 2008) This has happen because of credit crisis which started in the sub prime mortgage market. The purpose of this essay is to discuss the meaning of sub prime mortgage crisis and to analyze the causes and the risk to Malaysia’s various markets. In particular the focus is to the affected industry .Sub prime mortgage started in United States and had caused a deep slump in global trade including Malaysia.(Insap,2007) Finally a discussion on the mitigation step taken and their effectiveness to minimize the impact are presented in the essay.

The Definition of Sub prime Mortgage crisis

The commencement of the sub prime crisis can be map out back to the time when banks luring cheap short-term credit for sub prime borrowers a few years ago. (Aseambankers, 2008) The low interest rate environment has spurred increases in mortgage financing and substantial increases in house prices. (Crouhy et all.., 2008) The huge demand for these loans triggered the miscalculation of risk and made it possible for any consumer to buy a house. (Aseambankers, 2008) Individuals were speculating on the booming property market by buying multiple properties. The US federal Reserve in turn had kept interest rates low, thus giving consumer high reasonable price to own properties.( Aseambankers,2008) The lender primary consideration for loan quality was the ability to sell in the secondary market.(Gwinner & Sanders, 2008) A sub prime mortgage is to establish a loan to unqualified borrower. Often these borrowers have less or even no credit history. Sub prime mortgages often offer interest- only loans. Borrowers are to repay the interest towards the beginning of the loan tenure. (Amadeo, 2010)

Causes and risk of sub prime mortgage crisis. 

Sub prime mortgage market fall because of many reason involved. Researcher had proved that the securitizers were to some extent aware of it. (Demyanyk & Otto, 2008) August 2007, the sub prime mortgage problems started to surface in the financial market. The mortgage lenders were unable to repay their debt since the housing price bubble busted and their mortgage become larger than the value of their houses. (Insap, 2007) The fall of sub prime mortgage happens because of the unsustainable growth. (Demyanyk & Otto, 2008). Once the loan had been granted to poor credit histories borrower they are more likely to default. (Amadeo, 2010) Since the process of granting a loan is easy. This has driven the property prices increases in some areas given that the supply is the same. Banks and investors act procyclically, extending credit more aggressively and competing for market share as collateral prices rise.(Gwinner & Sanders, 2008)as oppose to the declining income growth in these sub primes zip codes and  their neighborhood. (Atif & Sufi, 2008)

In the first part of decade the interest rate were relatively low. Investor is looking for a better yield income. Subprime mortgage offer higher yield than standard mortgages and have been in demand for securitization.(Crouhy et all., 2008) Once the security back by mortgage has been issued, it may be traded from one investor to another.(Gallagher & Andrew, 2000) Generally the seller of this security have no other involvement in the process (meaning that investors rely purely on the mortgages as security and have no resource to the lender should borrower default).( Hunt & Terry , 2008) Secondary market transactions occurs thousand of times as investors trade securities among themselves. (Gallagher & Andrew, 2000)

Between 2001 and 2006, between 60 and 80 percent of sub prime loans were bundled into mortgage- backed securities and sold to investors in capital markets (Gwinner & Sanders, 2008) The theory of risk –return trade off is playing their part here, bank wouldn’t take additional risk unless they expect to be compensated with additional return. This axiom established the fundamental risk- return trade-off that govern the financial market (Keown et all, 1998)

Bank repackaged mortgages with different risk profiles and included a slice of sub prime loans to enhance the yield. (Aseambankers, 2008) This in contrast with the bank lending model followed in most emerging markets, where banks originate and holds the loans in their portfolios fund them with deposits and retain the risk of default. (Gwinner & Sanders, 2008)

Effectively, the banks were giving loans to people who could not afford the houses and selling the loans via all sorts of methods to other banks. The problem was those low rates were not really profitable, especially when the Fed was hiking up the lenders’ cost of funds at the same time. In order to boost profits, the sub prime lenders started raising their lending rates. When the interest rates were abruptly raised, monthly housing payments were raised substantially. This made it difficult for homeowners to pay their mortgages, they in turn started selling their homes. The subsequent effect was an oversupply of houses, which led property prices to drop. Speculators were losing money instead of making money. As a result, homeowners started defaulting and declaring bankruptcy. Banks that are provided the financial backing for these loans were affected when the borrowers started defaulting, and the collateralized debt obligations and mortgage-backed -securities could not be resold on the market. As a result, banks could not repurchase them as investment anymore and were forced to sell the papers before prices deteriorated further. In addition, banks refused to buy each other’s short term debt resulting in a vicious cycle of forced selling. (Aseambankers, 2008)

The cause and risk of sub prime mortgage crisis to the various market in Malaysia.

Primarily due to lesson learned in 1997 crisis, most Asian countries also have much better financial regulatory regimes in place than they did a decade ago. Their commercial banks have better corporate governance and better internal risk management and their corporate sectors have much lower leverage. Direct exposure to both sub-prime and derivatives overseas is limited. (APCO, 2008) Broadly speaking, there has been no sub prime mortgage lending in emerging markets. Instead, mortgage lending is typically made on conservative terms to middle and upper income households employed in formal sector, (Gwinner & Sanders, 2008) and their backwardness has prevented Asian lenders from moving into complex and sophisticated products.

Malaysia financial system has not been affected by the crisis and our economy is still resilient. (Benjamin, 2009) Malaysia Second Finance Minister ensures that Malaysia has sufficient tools and strengths within its economy to withstand a slowdown in the global economy. (Insap, 2007) Despite of the comment in the news that our financial market is not affected by sub prime mortgage crisis, Malaysia still feels the heat on the incident. The deep slump in world trade and commodity prices had a much bigger impact on Malaysia than expected.(Asian Development Bank, 2009)This is evidenced by our Kuala Lumpur Composite Index falling to a five month low of around 1,141 point on 18 August 2007 following from the Dow Jones fall. The credit squeeze caused by the sub prime mortgage crisis triggered global sell-off equities. The spooked investor in our own local bond market, setting of a selling frenzy, which pushed the yield curve higher as will be shown next. (Wee, 2007)

Malaysia’s bond market, which has been existence since 1960s, saw numerous institution developments during the late 1980s. Important changes include the establishment of national mortgage corporation Cagamas in 1986 to develop the secondary market in our capital market via securitization of housing loans. (MIF, 2008) In principal Malaysia market securitization has not reach the level as what is happening in United States. However the losses suffer by Malaysia financial market will be indirect losses which may come from their investment in purchasing bonds or equities in the infected western financial institution. (James et al.,2008)It is true that the sub prime crisis and the likely US recession have taken a toll on Malaysia bond market and the  Islamic Sukuk too, despite our financial market especially the bond market is one of the most developed in the region.(Benjamin,2009)

The second industries that is badly affected by the US sub prime crisis is the export dependent manufacturing sector, was particularly vulnerable to the global crisis. (Nambiar, 2009) Malaysia’s export are closely tied to the US economy.(Insap, 2007) It has been observed, that the current crisis has had an impact on Malaysia through the contraction of trade and FDI inflows (James et al.,2008)These declined have resulted in labor market shocks which have led to retrenchments. (Nambiar, 2009)

The banking sector lies at the very core of Asian financial systems, and the banking sector has been largely unscathed. (Asian Development Bank, 2009)  The adverse impact of global financial crisis on Malaysia has been limited and transmitted through indirect, peripheral channels.(James et al., 2008) Various financial indicators and banking sector data support the contention that Asia’s financial system were well prepared for the crisis. Nonetheless, stock prices in Asia were closely linked to global markets and suffered badly in 2008. Although Malaysia has not been directly impact by the sub prime mortgage crisis, steps are taken to cushion the related industry. Next, the reader will be taken into the step taken by the Malaysia government to minimize the impact of sub prime mortgage crisis.

Steps taken by the government and central bank to mitigate the impact of sub prime crisis

The Malaysian economy is expected to benefit from ongoing measures globally to stabilize economic conditions through fiscal measures and loose monetary policy, as growth is projected to rebound into positive territory in 2010. (Jagdev et all…, 2009) Malaysia government rolled out two fiscal stimulus package, and interest rate were lowered to spur the economy, an easing of monetary policy, and a relaxation of local equity requirement for some foreign investor are among the incentive offered. (Asian Development Bank, 2009)

The first fiscal stimulus package includes seven billion spending announced in November 2008 and the Ringgit Malaysia sixty billion spending under the Mini budget announced in March. Malaysia Prime Minister, Datuk Seri Najib Tun Razak has committed an extra Ringgit Malaysia one billion per month until the end of 2010 to pump – prime the domestic economy. The move is to lend additional crutch to the local economy to find growth. (Kok, 2009)

In response to the deteriorating domestic economy and slowing inflation, Bank Negara Malaysia, the central bank reduced its policy interest rate in steps from 3.5% at the beginning of November 2009 to 2.0% in February 2009, and its reserve ratio for commercial banks to a record low of 1% from 3.5% in November 2008. The second is a trade weighted depreciation of the currency has further relaxed financial conditions. (Asian Development Bank, 2009)

Other than the financial stimulus and the interest reduction, the government is also activating back the Corporate Debt Restructuring Committee was establishes during the 1997/98 Asian Financial crisis to assist companies with debt problems. CDRC (Jagdev et all., 2009)

In other changes, the Government reduced the minimum stake to be reserved for Bumiputra investors in initial public offerings to 12.5% from 30% and eased rules on foreign investors buying stakes in Malaysian companies and property. (Asian Development Bank, 2009)

Evaluation of effectiveness of steps taken by the government and Malaysia Central Bank

The year 2010 is a recovery year. If recovery is strong, we may find ourselves achieving even higher growth with the additional government spending. (Kok, 2009) Now we can see that there are sign of improvement in the global economy. (Andrew, 2010)Malaysia economy contracted by 5.1% in the first half of 2009, more sharply than expected. On the production side, only services grew, while manufacturing output, which is dominated by export–oriented industries, contracted sharply and agricultural production declined. (Asian Development Bank, 2009) Whilst on the stock market the benchmark index FTSE Bursa Malaysia KLCI, was on rally last seen during the heydays of the Malaysian economy in the early 1990s. Stock on Bursa Malaysia rallied uninterrupted for 13 straight days as investor interest returned for a number of reasons. The sub-prime mortgage crisis tragedy offered low yields on stocks, real estate, bonds (Andrew, 2009) Hence we have not seen the end of the crisis. (Andrew, 2010) It was early to conclude that the economy is recovering or that the step taken by the government is effective. The better outlook is underpinned by the fiscal stimulus and the expected recovery in world trade and commodity prices. (Asian Development Bank, 2009)

So far global growth has been due to fiscal pump primp and historically low interest rate. The steps taken by Malaysia’s government has seen the situation whereby the financial markets are having a huge profit after the governments have rescued the financial institutions by massive guarantees and zero interest rate policy. (Andrew, 2009) One thing that could stop the recovery in its track is a premature exit from stimulus spending. (Kook, 2009)

While on the recovery side, CDRC (Corporate Debt Restructuring Committee) was reactivated as a pre-emptive measure to help distressed companies during the current economic downturn. This action to reactivate the CDRC may not be as efficient as the small number indicates the corporate position now than during the Asian financial crisis. (Jagdev et all..,2009)

Conclusion

In conclusion we can say that greed, fraud, problem resulting in lack underwriting standards, incentive issues, failure to identify a changing environment, poor risk management by financial institution, lack of transparency, the limitation of extant valuation models and the failure of regulators to understand the implications of the changing environment for the financial system is the major reason for the fall of the sub prime mortgage. Helping people to get a house to is a noble job, but without proper mitigation to the risk will make the economy suffer, when the bubble bust. In summary it is clear that U.S. sub prime crisis has an effect to Malaysia, as an emerging market. This essay has satisfied the purpose of defining and identifying the root of sub prime crisis and the affect of it to Malaysia economy.

List of references:

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For My Student - Example Only - Economics

2008 Assignment 

(Question 2 ) 

Question : 

In recent times, the oil price increase has sparked concerns about inflationary pressures and some economists fear the threat of stagflation. Maintaining a stable inflation rate is one of the key macroeconomic objectives of governments.

Select a country of your choice and discuss the causes and effects of inflation, why governments need to control inflation and how that country use macroeconomic policies to ensure a stable rate of inflation.

 Executive summary

Economists seem to agree that high rates of inflation cause “problems,” not just for some individuals, but for aggregate economic performance. However, much less agreement exists about the precise relationship between inflation and economic performance, and the mechanism by which inflation affects economic activity. In recent times, the oil price increase has sparked concerns about inflationary pressures and some economists fear the threat of stagflation. Maintaining a low and stable inflation rate has become one of the challenges in the macroeconomic management of most countries. Among others, Malaysia has a very unique experience in terms of inflation. The economy has experienced episodes of high and low regimes of inflation, and was able to contain low and stable inflation during the high economic growth period of 1988-1996. The objective of this study is to identify the causes and effects of inflation and to discuss, why governments need to control inflation and how Malaysia use macroeconomic policies to ensure a stable rate of inflation. Research method used is through qualified referencing from journal, article and text book. The empirical results of this study show that external factors such as exchange rate and the rest of ASEAN’s inflation are relatively important factor in explaining Malaysian inflation rather than the oil price mainly.

Table of Contents

Executive Summary                                                                                       

                                                                                                                                    Page

1.                  Introduction                                                                                              

2.                  Malaysia’s Economy                                                                                 

3.                  Inflation in Malaysia                                                                                 

4.                  Inflation                                                                                                   

5.                  Types of Inflation                                                                                     

5.1 Monetarist explanations of inflation                                                   

5.2 Keynesians explanations of inflation and money supply                    

6.                  The Effects of Inflation                                                                         

7.                  Anti- Inflation prices                                                                            

8.                  Recommendation                                                                                

9.                  Conclusion                                                                                         

10.              References                                                                                                

11.              Appendix                                                                                                  

  

1.         Introduction

The issue relating to inflation has generated an enormous volume of literature and heated debate in recent years. Different schools of thought, from classical, Keynesian, monetary to structural, each carry different banners and offering different evidence on the nature and causes of inflation.(Cheng & Tan:2002)The recent price hike in oil price is driven by tight fundamentals, reflected by low available crude oil surplus production capacity, combined with supply concerns in several oil exporting countries, have continued to put upward pressure on world crude oil prices, evidenced by low available surplus capacity and Organization for Economic Cooperation and Development (OECD) inventories that are below 5-year average levels. (Short-Term Energy Outlook: 2008) Referring to the exhibit 1, the author can conclude that the oil price increase is not a new issue for the country. Among others, Malaysia has a very unique experience in terms of inflation. The economy has experienced episodes of high (1973-1974, 1980-1981) and low (1985-1987) regimes of inflation, and was able to contain low and stable inflation during the high economic growth period of 1988-1996. In this case of Malaysia, exchange rate is an important determinant of inflation in the country (Cheng & Tan: 2002)

 2.         Malaysia’s Economy

As an emerging market economy, Malaysia is clearly a success story. (Liu: 2001) From a country dependent on agriculture and primary commodities in the sixties, Malaysia has today become an export-driven economy. (Malaysia’s economic strength: 2008) Malaysia has progressed into a nation that has diversified successfully to rise as a top exporter of manufactured goods.  Other items exported are palm oil and rubber, in which Malaysia is among the top producers, as well as crude petroleum and liquefied natural gas.  Malaysia is considered a major producer of cocoa and pepper, with significant exports of timber and wood products. (Malaysia’s Economy: 2008)Malaysia is the largest producer of palm oil in the world.  In 1996, 7.3 million tons of palm oil products were exported. The third largest in natural rubber production, Malaysia exported 17.1 percent of the world's production in 1996. (Malaysia’s Economy: 2008) During the last decade, the Malaysian economy achieved average annual growth rates of about 7% while GDP doubled to reach an estimated RM219.4 billion (US$57.7 billion) in 2002. Exports and imports have almost quadrupled to reach RM349.6 billion (US$92.0 billion) and RM298.5 billion (US$78.6 billion) respectively, placing Malaysia among the world's top 20 trading nations. (Malaysia’s economic strength: 2008) Malaysia's development plans were implemented effectively. Much of the investment went into electronics and other export-oriented industries, while a large portion also went into nontradable sectors including capital-intensive infrastructure and the real estate sector. (Liu:2001)

 3.         Inflation in Malaysia

Malaysia development plans were initially financed by public funds. As a result, by the early 1980s, growth was accompanied by increased budget deficits and an unsustainable level of public debt. The authorities took measures to reduce the government deficit, and successfully restored fiscal prudence. Structural adjustments were also undertaken, including an open trade and payments system that helped expand rapidly Malaysia's export base. Sustained high growth during the 1980s brought significant improvements in living standards and social cohesion. Economic diversification, coupled with deregulation and liberalization of the financial system, also helped transform the country into a middle-income emerging market by the end of that decade. (Liu: 2001)With oil prices approaching the symbolic threshold of $100 a barrel, the world is headed toward its third energy shock in a generation. But today’s surge is fundamentally different from the previous oil crises, with broad and longer-lasting global implications. In the history of inflationary experiences in Malaysia, 1973 and 1974 were exceptional years. Inflation rose significantly in both the international and domestic markets in 1973. The sharp oil price increase in 1973 and 1974 was the principal reason for the escalation of world inflation in 1973-1974. Malaysia experienced a second episode of high prices in 1980 and 1981, which were due mainly to external factors. Oil prices rose by 47 per cent in 1979 and 66 per cent in 1981. At the same time, inflation in Malaysia accelerated from 3.6 per cent in 1979 to 9.62 per cent in 1981.(Cheng & Tan:2002) Looking back into history of inflation in Malaysia, the country had experience a several crisis which made the inflation creep up tremendously. In the year 1985 the economic performance of the country had slumped into its greatest recession, with 1.1 per cent growth rate. The severity of the international economic recession during the early 1980s imposed considerable constraints on the growth and development of the nation in 1985. After registering a significant growth with more than 8 per cent for three consecutive years, the economy in 1990 strengthened further in the country despite some slowing down of growth in the industrial countries. The problem of inflation in Malaysia was relatively well controlled during the recent financial crisis period compared to her neighboring countries, for example Indonesia, which experienced a high inflation rate of more than 60 per cent in the midst of the crisis in 1998. After experiencing an economic downturn for approximately two years since mid-1997 due to the financial shocks, the Malaysian economy has began to pick up again from the third quarter of 1999 and the pressure on consumer prices has therefore subdued to a substantial extent. The inflation rate for the first quarter of 2000 has registered at a level that was compatible with the pre-crisis rate of less than 3 per cent. (Cheng & Tan: 2002) Malaysia inflation rate is shown in exhibit 2. Malaysia is important to world energy markets because of its huge oil and natural gas resorts. Malaysia. Main importers of Malaysian oil are Japan, Thailand, South Korea and Singapore. Malaysia‘s natural gas has been rising steadily in recent years. In 2000, Malaysia accounted for approximately 15% of total liquefied natural gas exports and is estimated to contain a 75 trillion cubic feet natural gas resort. (Malaysia Oil and Gas Industry: 2008) Whilst Malaysia is exporting oil, on the other hand it is importing good from oversea. The increase in cost of doing business will have an impact on Malaysia inflation rate. Malaysia mainly imports electric & electronic equipment, machinery, mineral fuels & oils, plastics, and iron & steel. Malaysia total import and export details are shown in the exhibit 3.

4.         Inflation  

Inflation is a situation in which the general price level is persistently moving upwards. (Stanlake & Grant: 1995) According to Webster's 2000 definition of inflation is, a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. Oil is a major component of both consumer prices and producer prices. Rising fuel costs can trigger a compounding effect. (If fuel costs rise everything else will have to rise to cover the additional costs incurred by the producers of the products). However, this increase in prices would normally be the result of an increase in the money supply although it can also be a result of a decrease in the supply of oil. (Mahon: 2008)

Goals of economic policy consist of value judgments about what economic policy should strive to achieve and therefore fall under the heading of normative economics. While there is much disagreement about the appropriate goals of economics policy, several appear to have wide, although not universal, acceptance. These widely accepted goals include:

a)      Economic growth: Economic growth means that the incomes of all consumers and firms (after accounting for inflation) are increasing over time.

b)      Full employment: The goal of full employment is that every member of the labor force who wants to work is able to find work.

c)      Price stability: The goals of price stability is to prevent increases in the general price level known as inflation, as well as decreases in the general price level known as deflation. (Duffy: 1993)

5.         Types of Inflation

Inflation may be classified according to the rate of increase in prices. The 'rate of inflation' is the percentage increase in the Retail Price Index (RPI) over the period of one year. There are different degrees of inflation. It includes mild inflation, strato-inflation and hyper-inflation. (Hao: 2006) Oil price fluctuation exerts a distinctive important influence on inflation throughout the world. (Piana: 2001)

Mild inflation is a slow rise in price level of no more than 5 percent per annum. It is associated with a low level of unemployment and is during the upswing phase of a trade cycle. Such creeping inflation has beneficial effects on an economy. It is a sign of a buoyant economy or an expanding economy, implying the generation of jobs, output and growth. (Hao: 2006) This refers to situation where demands exceed supply, but the effect on prices is minimized by the use of such devices as price controls and rationing.

For strato-inflation, the inflation rate ranges from about 10 percent to several hundred per cent. Many developing countries particularly those in Latin America experienced this. (Hao: 2006)

In an extreme form of inflation, prices rise at phenomenal rate and terms such as hyperinflation, runaway inflation, or galloping inflation have been used to describe these conditions. (Stanlake & Grant: 1995) This usually leads to the breakdown of the country's monetary system as the existing currency may have to be withdrawn and a new one introduced. In 1923, the inflation rate in Germany averaged 322 percent per month with the highest inflation rate at 29 000 percent in October. (Hao: 2006)

Traditionally Keynesians have classified the causes of inflation as demand-pull or cost push. Demand Inflation may be defined as a situation where aggregate demand persistently exceeds aggregate supply at current prices so that prices are being pulled upwards. Demand inflation is likely to be associated with either full employment or rising employment, whereas it is possible that cost –push inflation may be associated with rising unemployment. (Stanlake & Grant: 1995)Malaysia unemployment rate in 2001is at 3.9%. in year 2004. (Labour Market: 2006)

5.1       Monetarist explanations of inflation

Monetarist believe that the main cause of inflation is the growth of the money supply. Many of them believe that this is the sole cause. They argue that excess demand or rising costs are symptoms of inflation and not the cause. Monetarist theory holds that there is a strong direct connection between the supply of money and total spending. (Stanlake & Grant: 1995)

            5.2       Keynesians explanations of inflation and money supply

Economists agree that inflation is a monetary phenomenon in the sense that it will be combined with an increase in the money supply. However, whilst monetarists believe that inflation is caused by increases in the money supply, Keynesians believe that inflation causes an increase in the money supply. If the general price level is rising, firms and individuals will borrow more to meet higher costs and prices, and the resulting higher bank lending will increase the money supply. (Stanlake & Grant: 1995)

  

6.         The Effects of Inflation

Inflation can have a number of effects, many of which are considered undesirable. Malaysia experienced a second episode of high prices in 1980 and 1981, which were due mainly to external factors. At current price of oil is escalating will further press the inflation up. The gross domestic product (GDP) figures released by Bank Negara Malaysia showed that the economy expanded at a blistering pace of 7.3 percent for the fourth quarter last year and a full-year growth of 6.3 percent, which beat market expectations.
"The momentum is excellent. The target for 2007 was only 6.0 percent but we achieved 6.3 percent in a challenging environment," Malaysia second Finance Minister,  Nor Mohamed told reporters.

a)      Inflation leads to an arbitrary redistribution of real income. Although a rise in the general price level produces a corresponding rise in money incomes, all prices do not risen to the same extend and different income groups will be affected in different ways. Income recipient whose income is derived from a fixed source will experience a fall in their real incomes.

b)      Effect on production, demand pull inflation is associated with buoyant trading conditions and sellers’ markets where the risks of trading are greatly reduced. This is not likely to be the case in cost push inflation where trading conditions are likely to place a premium on greater efficiency.

c)      Effect on the balance of payment in economies as the UK which is dependent upon a high level of export and imports, inflation often leads to balance of payments difficulties. (Stanlake & Grant: 1995)

7.         Anti- Inflation prices

Country can reduce inflation by temporarily reducing output and raising unemployment. The cost of reducing inflation varies depending upon the country. Because of the high costs of reducing inflation through inflation through recession, country often looks for other approach. There is a need, particularly for the fast developing countries, to empirically examine the causes of inflation by incorporating both monetary and fiscal factors. Policies to control inflation are directed towards control of aggregate demand (Demand- side of policy) or of aggregate supply (supply-side policies)

Demand- side policies fall into two types:

a)      Monetary policy involves alteration in the money supply and/or changes in the rate of interest. Malaysia's economic vulnerabilities stepped up significantly from early 1997 through the period following the onset of the crisis in mid-1997. The initial response of the authorities was to hike interest rates and tighten fiscal policy in an attempt to anchor market confidence in the financial system. (Liu:2001) With the outburst of the financial crisis in Asia starting July 1997, interest rates, fuel prices and prices of goods and services have increased .Robust foreign demand as a result of the depreciation of the Malaysian Ringgit (RM) of over 40 per cent has placed an extremely powerful inflationary pressure on Malaysia. However, the prudent and immediate action taken by the government on September 2, 1998 to effectively fix the nation’s currency to the US dollar at US$1=RM3.80 has had some controlling effect on inflation in the country. In addition, interest rate policies have been formulated towards preventing inflation in the country, as inflation obviation has remained the key government policy throughout the years. (Cheng & Tan:2002)

b)      Fiscal Policy involves changing government expenditure or taxation to affect aggregate demand. In early 1998, fiscal policy was revised to a more expansionary stance. (Liu:2001)Expansionary fiscal policy is happening when the government is increasing their spending. This policy mix proved to be insufficient to correct external imbalances and bring about the needed economic adjustment. The contagion effects of the crisis and the associated economic contraction were far worse than anticipated. Domestic imbalances quickly emerged as growth rates slowed and then turned sharply negative in early 1998. Market confidence faltered amid adverse regional developments and uncertainties. Anticipation of further devaluation of the ringgit heightened. By the summer of 1998, the stock market had fallen to its lowest level in recent history. In September 1998, the Malaysian authorities launched a policy package designed to insulate monetary policy from external volatility. Measures included by a fiscal stimulus package that stepped up capital spending. These measures permitted the subsequent lowering of interest rates. The authorities also pursued fundamental reforms in the financial and corporate sectors, including a bank consolidation program and an upgrading of prudential regulation and supervision in line with international best practices.(Liu:2001)

Malaysia's recovery in 1999–2000 was among the strongest of the Asian crisis economies, led by buoyant world demand for electronics and supported by accommodating macroeconomic policies. The external current account turned into large surpluses, allowing a buildup of international reserves. Unemployment declined, and inflation remained low. The strong growth and a gradual easing of capital controls helped improve investor confidence. The recovery was also accompanied by reduced vulnerability of the financial system. Although operational restructuring of the corporate sector has been somewhat slow, much progress was achieved with corporate debt restructuring. (Liu: 2001)

8.         Recommendation

Oil price increasing is beyond the country control. Malaysia government can only control the internal factor or the cause and effect of inflation within country. Few steps that have been taken to increased the consumer spending. Malaysia government had launched the “zero inflation campaign” on 2 June 1995 to marked the government’s strong intention to curb the inflation in the country. Other attribute is to countermeasures in controlling overheated expansion in domestic demand in Malaysia, such as the restriction of consumption through the imposition of a tax on expensive luxury items and an increase in minimum credit card repayments, as well as the provision of savings incentives and the imposition of real estate transaction taxes to curb real estate speculation. The control items where prices are supervised by the government caused domestic influences on domestic price to be suppressed. After all the measured step taken by government to curb the inflation, domestic variables such as income variable did not seem to have a significant direct impact on inflation. Among all the domestic factors, government expenditure and private consumption are the two most important factors in influencing inflation in the long run. However, the impacts of these two factors are not as significant as external influences, particularly the rest of the ASEAN’s inflation. (Cheng & Tan: 2002) Looking ahead, the issue is how Malaysia can better protect itself from future shocks and avoid another crisis.

9.         Conclusion

Malaysia is oil producing country and the other commodity. The question is why are Malaysia is so vulnerable to the effect of rising in oil price. The answer to this question is that we import so many other goods to fulfill the consumer and government needs. Oil price is not a major cause to the inflation, it is a symptom to an inflation hike. The estimated results of this study indicate that, besides the domestic factors which include private consumption, government expenditure, interest rate and money supply, external factors also have a significant influence on Malaysian inflation. Malaysia had survived the crisis in many times and with the wise government decision they will continue to rebound. Inflation thus once again becomes an important issue and the focus of the government in macroeconomic management.

10        References 

11.       Appendix

Oil Price Chart

Price Summary
	Year				Percent Change
	2006	2007	2008	2009	06-07	07-08	08-09
WTI Crudea ($/barrel)	66.02	72.32	94.11	85.92	9.5	30.1	-8.7
Gasolineb ($/gal)	2.58	2.81	3.21	3.06	8.9	14.5	-4.7
Dieselc ($/gal)	2.70	2.88	3.45	3.22	6.6	19.6	-6.5
Heating Oild ($/gal)	2.48	2.72	3.33	3.12	9.4	22.4	-6.3
Natural Gasd ($/mcf)	13.75	13.00	13.84	13.87	-5.4	6.4	0.2
a West Texas Intermediate.   b Average regular pump price.

(Short-Term Energy Outlook: 2008)

Exhibit 1

Malaysia Inflation Rate

Year	Inflation rate (consumer prices)	Rank	Percent Change	Date of Information
2003	1.90 %	168		2002 est.
2004	1.10 %	189	-42.11 %	2003 est.
2005	1.30 %	31	18.18 %	2004 est.
2006	3.00 %	90	130.77 %	2005 est.
2007	3.80 %	111	26.67 %	2006 est.

(Malaysia Inflation Rate: 2008)

Exhibit 2

   

Summary of Malaysia's Trade By Month (2007)
Value in RM Billion

Month	Total Import	Total Export
January	40.38	46.99
February	34.17	41.10
March	42.46	48.99
April	40.29	46.16
May	41.70	49.68
June	40.39	49.17
July	42.53	50.51
August	45.06	53.87
September	42.69	54.16
October	46.28	54.87
November	44.06	54.46
December	44.50	54.11

(MATRADE:2008)

Exhibit 3