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.
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
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. (: 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)
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)
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 Malaysia
"The momentum is excellent. The target for 2007 was only 6.0 percent but we achieved 6.3 percent in a challenging environment,"Malaysia
"The momentum is excellent. The target for 2007 was only 6.0 percent but we achieved 6.3 percent in a challenging environment,"
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)
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
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
|
|||||||
(: 2008)
Exhibit 1
|
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
|
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
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