Monetary Policy Essay

ASEAN countries are completely more sensitive to oil price increase and intensive in production
than other nations or economies. Thus, oil price shocks seem possibly brought negative impact
to ASEAN countries including modest effects on inflation and interest rates. One of the most
impact from oil price changes is on inflation rate. Fluctuation in inflation may further lead to
economic changes which can influence the economic performance whereby oil prices directly
affect the prices of goods made with petroleum products. In a short run, the rising of oil prices
indirectly influence costs such as transportation, manufacturing, and heating. The increase in
these costs can in turn affect the costs of a variety of products and services. Whereas in long-
term effects, rising oil cost can stifle the development of the economy through their impact on
the supply and demand for products other than oil. It can moreover discourage the supply of
other goods since it can increase the costs of production.

Due to this reason, oil price will influence the ASEAN economies both their impact on the world
economic activity, exchange rate and interest rates. One thing that ASEAN economies have in
common is that they are all trading economies with high exchange and export share. Besides, as
small open economies with high level of investment, they are too sensitive to the impacts of oil
prices on financial markets on financial flows, interest rates and exchange rates. Additionally,
they are also sensitive to the direct impacts of rising global oil prices and their oil imports and
hence on domestic prices. There are three transmission channels of an oil price shocks to
ASEAN economies. To begin with is the world oil demand, world oil price and world oil supply.
These three have a direct and global impacts. The direct impacts are oil import prices and oil
export prices in which ASEAN economies activity, inflation, monetary policy and fiscal policy are
influenced. On the other hand, global impacts corresponds real and financial. In real, GDP
growth, consumption and import demand are affected. Whereas in financial, exchange rates,
imbalances and interest rates are influenced that can also impact bond rates and investment
climate.

The policy response to an oil price shock depends on how that shock impacts on the economy.
The key to having the best possible policy response is in foreseeing how rising oil prices will
impact on inflation and activity, both in the short and medium-terms and altering policy
accordingly. Subsequently, the experience of the 1970s and 1980s demonstrated that early
intervention to address inflation is the foremost effective response to an oil price shock.
Correspondingly, the appropriate policy response varies according to the circumstance of the
country in oil exporting country with floating exchange rate monetary policy will need to
respond to higher inflation. The degree of the response depends on the impacts of higher prices
on household income, employment and demand as well as the impact coming from global
markets on export demand, investment flows, exchange rates and interest rates .Whereas fiscal
policy under oil exporting country with floating exchange rate, the revenue will increase and
the budget move into surplus, especially if oil production is by state owned-oil companies. It is
good to let this happen as inflation is bought under control. However, the broad policy lessons
that can be drawn from this experience is that it is way better for monetary policy to respond
prior rather than later. The experience also highlighted the significance of the interaction of
macroeconomic and microeconomic policies. Low macroeconomic responses exposed to flaws
in regulation arrangement in labor and product markets and this in turn implied that the
appropriate macro policy response was harder to implement.

Therefore, monetary and fiscal authorities key to understand the factors that are driving the
increase of oil price is to make a judgment about how persistent an increase in oil price will be.
This is really no different to the more generalized problem of setting policy in response to
advancing economic circumstances. It is additionally the key reason why there are no settled
rules around how to respond to an oil price shock. Each shock should be judged on its own
merits and considered with all other components that are affecting on the outlook in making
judgements almost the appropriate stance of financial and monetary policy. I believe that good
microeconomic policy gives macroeconomic policy more room to move while great
macroeconomic policy creates an environment in which microeconomic and basic reforms can
take place.