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PRINCIPLES OF ECONOMICS
UDC1002
TITLE :
(INFLATION)
LECTURER :
We would like to take this chance to express our warmest gratitude to our lecturer,
Madam Che Suzana Aida for helping me with this homework. We appreciate you taking the time
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TABLE OF CONTENTS
ACKNOWLEDGEMENT ….…………………………………………………………………..…………2
Inflation is defined as a sustained increase in the general price level which is often
referred to as an average of prices of goods and services in the entire economy and not only
exclusive to the price of any one particular good or service. To simply understand inflation, let’s
take McDonald’s for an example. In 2021, a Big Mac burger meal would cost around RM17.50.
Currently in 2022, the same large Big Mac burger meal is sold for RM20.50. That is a 17.1%
increase in price for the same Big Mac burger meal compared to the previous year. Another
example is, a hundred Ringgit Malaysia note (RM100) that is worth 8% less than it used to be a
year ago. There are two common causes of inflation identified by economists, among them are
cost-push inflation and demand-pull inflation.
Inflation rates are calculated by subtracting the Consumer Price Index (CPI) of the
current year with the CPI of the previous year and dividing it with the CPI of the previous year.
Later, it is multiplied with a hundred to obtain the rate in units of percentage. Consumer Price
Index (CPI) also depends on regional or cultural factors and differs for different income earners.
So what is an appropriate rate of inflation? Most governments target 2-3% inflation rate per year
to maintain the price stability as it contributes to the sustainability of the country’s economic
growth. The Department of Statistics Malaysia has recently published the consumer price index
for September 2022 which recorded a 4.5% inflation rate, lower than the previous month,
August 2022 which recorded a 4.7% inflation rate. So what does this mean for the country’s
economy?
Small rates of inflation is good as it is helping the country’s economy grow and it helps
economies stroll away from deflation. It is also good news for people who are in debt because
the government fixes low interest rates to encourage economic activities such as borrowing
loans to purchase a house or a car. Inflation also helps to provide job opportunities as the
country’s economy is blooming. For instance, the demand for cars from consumers is
increasing. Therefore, factories will hire more employees to increase their manpower. However,
the bad news is savings do not help during inflation because the value of the total amount of
your savings might be 30% less than the amount it was 4 years ago. Therefore, saving for
desperate times in case inflation occurs does not help very well. In addition, income, prices and
housing rates do not increase at the same rate during inflation and if prices are increasing and
income stays the same rate, it poses a risk for poverty towards the people and may lead to a
financial recession.
1.1 TYPES OF INFLATION
Cost-push inflation is defined as a phenomenon in which general price levels rise due to
increase in the cost of wages and raw materials. Cost-push Inflation most commonly occurs due
to these three factors. Firstly, the increase of raw material prices. Secondly, increase in wages
due to employee’s demand which could be the result of the high cost of living or there are plenty
of well-trained workers in the field that companies require. Lastly, increase in rent in cities where
fresh-graduates and people are moving in every year for better opportunities.
Purchasing power will decline as a result of inflation. One's purchasing power will
decrease as a result of having to spend more money in order to purchase the same
amount of goods or services as before. For instance, while a loaf of bread cost RM1.50
in 1980, it would cost RM5.50 to purchase it in 2022. The greater price represents 40
years of significant inflation that has reduced people’s purchasing power. Cost of living
goes up over time due to inflation. The economy suffers if the rate of inflation is too high.
Cost of living is the amount of money needed to cover basic expenses such as
housing, food, taxes, and medical care in a particular place and time. Cost of living is
often used to compare the cost of living in one city to another. Living expenses are linked
to wages. For example, if spending is high in a city like Kuala Lumpur, wage levels need
to be higher for people to be able to afford to live in that city. The text below explained
how the cost of living is interrelated to inflation.
Consumers must spend a larger portion of their income to maintain their current
standard of life as prices for products and services rise. Consumers will have to spend
more even on basic necessities if salaries do not increase proportionately. The majority
of individuals experience the effects of rising costs of living on a daily basis. However,
the middle class and the lower paid are particularly heavily hit by growing prices, since
the minimum wage does not always increase during times of inflation. Less money is
available for savings or ability to spend as a result of rising food, gas, and utility
expenses. Consumers reduce their purchases and shift to less expensive options or
search harder for discounts as a result.
This means buying new cars, refrigerators, phones, and other consumer items
for the average person. However, this goes beyond consumer items. Consumers are
also encouraged to seek the highest return on investment. As money loses value due to
inflation, it must be "beat" in order to preserve the same purchasing power.
Those with high amounts of debt, whether a firm, the government, or the
consumer, may profit from greater levels of inflation. For example, the borrower may
have a loan with a 2% interest rate. If inflation is 10% and their income grows at the
same pace, the effective rate at which they are repaying falls.
Although this can be a favorable consequence of inflation for people who are in
debt, it can be a tremendous disadvantage for individuals such as savers and
organizations such as banks. Banks suffer because their interest rates are lower than
the rate of inflation. And savers are likely to earn interest at or below the rate of inflation
2.2 SOLUTION BY THE GOVERNMENT
2.2.1 SUBSIDY
There are several tools for contractionary monetary policy. One of them is to
increase the short-term interest rate. Interest rates are the primary monetary policy tool
of a central bank. Commercial banks can usually take short-term loans from the central
bank to meet short-term liquidity shortages. In return for the loans, the central bank
charges the short-term interest rate. In order to reduce the money supply, the central
bank can optimize to increase the cost of short-term debt by increasing the short-term
interest rate. If the money supply goes down, the demands for goods will reduce hence
causing a price fall. Therefore, it will grant economic stability.
Fiscal policy refers to the budgetary policy of the government, which involves the
government controlling its level of spending and tax rates within the economy. There are
two main policy tools that federal governments have at their disposal in order to regulate
their economies, both in the short-run and long-term: taxation and spending. These two
tools are referred to collectively as “fiscal policy”. These are tools that the federal
government can use to help mitigate inflation, unemployment, and recession. Fiscal
policy is used to help balance the economy and level out the business cycle. To enact
contractionary fiscal policy, the government may decrease spending, increase taxes, and
enact a combination of decreased spending and increased taxation
According to the Official Portal of the Ministry of Finance Malaysia, the external
spillover effect from the recovery in global demand, including the continued increase in
trade activities have contributed to Malaysia’s economic recovery. This is evident
through the GDP performance for the first quarter of 2021 (Q1 2021) which contracted at
a smaller rate of 0.5% on a year-on-year basis compared to the 3.4% contraction in the
fourth quarter of 2020. This was also contributed by the recovery in GDP growth in
March 2021, which increased 6% year-on-year, the highest in the past 12 months. The
Malaysian Government is confident its fiscal strategy will ensure that economic growth
prospects remain strong in the medium to longer term to fulfill the country's development
agenda.
2.2.4 SELLING GOVERNMENT BOND ON THE OPEN MARKET
The variety of fixed income instruments, or bonds as they are often known, offers
investors a large selection of investments to suit their demands. Depending on the
investor's level of discretionary income, his or her tax band, and the tax benefit they
anticipate from their investments, each person may have different financial goals. When
deciding whether to invest in bonds, investors must take into account a variety of factors.
Among other things, these factors could take the interest rate, bond maturity, redemption
terms, credit quality, and credit ratings into account.
2.2.5 TIGHTENING SELECTIVE CREDIT CONTROL
The Central Bank of Malaysia Bank Negara Malaysia (BNM) is charged for
developing and carrying out the monetary policy. In September 2022, The bank Negara
Malaysia (BNM) Monetary policy Committee decided to increase the overnight policy
rate (OPR) by 25 basis points to 2.50% for the third time in a row which is in May,July
and September to control the country’s inflation rate.
However, The Monetary Policy Committee (MPC) of Bank Negara Malaysia
decided to increase the Overnight Policy Rate (OPR) again for the fourth time in a row
by 25 basis points to 2.75% in November 2022. This clearly shows that the policy
applied by the Monetary Policy Committee of Bank Negara Malaysia are less effective in
controlling the inflation rate.
Firstly, the policy that can be effective to control the inflation rate is by reducing
demand. By reducing government spending or increasing taxes,contractionary fiscal policy can
reduce demand for goods and services in the economy. This can help to curb inflation by putting
downward pressure on prices.
Lastly, Reducing expectations of future inflation are also one of the fiscal policy
that maybe effective to reduce the inflation rate. The government can assist in lowering
expectations of future inflation by proving its commitment to reducing it through the deployment
of contractionary fiscal policies. This may reduce current inflation because businesses and
consumers may be less willing to take actions that potentially result in price increases.
2.3.4 The effectiveness of Selling Government Bond On The Open Market
Selling government bonds on the open market is a type of monetary policy that
can be used to reduce the level of inflation in an economy. When the government sells bonds, it
is essentially borrowing money from investors. As the result of selling bonds it may help to
reduce inflation in a number of ways.
First of all, Tightening monetary policy.The government can lower the amount of
money in circulation by selling bonds on the open market. This may contribute to tightening
monetary policy, which may reduce inflation.
Tightening selective credit control is a monetary policy tool that the central bank
can use to reduce inflation in an economy. It entails using various measures to restrict credit
flow to specific sectors or types of borrowers in order to reduce demand for goods and services.
Reduced demand in the economy is one way that tightening selective credit
control can help to reduce inflation. When the central bank restricts the flow of credit to specific
sectors or types of borrowers, it can make borrowing and purchasing more difficult for these
entities. This can reduce demand for goods and services, putting downward pressure on prices
and helping to keep inflation at bay.
Tightening selective credit controls can also help to reduce inflation by allowing
the central bank to pursue a more restrictive monetary policy. When the central bank restricts
the flow of credit, borrowers may find it more difficult to obtain credit. This can discourage
borrowing and reduce demand for goods and services, helping to keep inflation in check.
3.0 CONCLUSION
In a nutshell, inflation isn't always a terrible thing, though in fact, a stable economy
requires a consistent level of inflation. Economists are aware that although high inflation poses
a significant risk, so does low inflation. Low inflation can result in chronically low interest rates,
just as excessive inflation can cause those rates to be permanently high. Permanently low
interest rates make it difficult for the Federal Reserve, the country's central bank (also known as
the Fed), to strengthen the economy during extremely difficult times, which can result in
protracted, severe recessions.
Inflation has a few positive effects on the economy such as it can stabilize economic
growth. This is because economic growth is indicated by modest inflation, and this growth can
be prolonged if it is sustained and mild. Consequently, consumers are able to continue taking
out loans and making purchases while businesses are able to generate more revenue since
prices and salaries naturally rise together. Furthermore, When demand is higher, businesses
are better equipped to set their prices. Better and more plentiful jobs for consumers are a result
of higher sales. When this turns into a positive cycle, this usually will obtain a better deal on the
goods.
3.1 RECOMMENDATION
There are many methods used to control inflation and, while none are sure bets, some
have been more effective and inflicted less collateral damage than others. Lets, take a look at
another country, America. In order to reduce inflation, the US government is implementing
supply-side policy reforms that complement the Federal Reserve’s attempts to cool demand
through monetary tightening.
There are tons of impacts such as it can reduce government spending and tamp down
on demand-fueled inflation, while at the same time restoring confidence in the ability of the
federal government to pay down the debt and thus control inflation expectations. On top of that,
removing barriers to work through occupational licensing reform, increased work flexibility, and
mitigating work disincentives in tax and transfer programs would increase labor force
participation, thereby reducing the cost of production for firms. Deregulation of energy, housing
and other markets would reduce the regulatory burden on businesses, lowering the cost of
domestic production and bringing down prices and also removing barriers to international supply
by reducing tariffs and eliminating regulatory barriers like the Jones Act and Foreign Dredge Act
would provide consumers access to cheaper goods and increase the resiliency of supply
chains.
4.0 REFERENCES
III. Department of Statistics Malaysia. (2021, October 21). Consumer Price Index Malaysia
September 2022. Retrived from
https://www.dosm.gov.my/v1/index.php?r=column/cthemeByCat&cat=106&bul_id=eTVE
Q25ubmtSS1g1MWtJWTI4ekxFQT09&menu_id=bThzTHQxN1ZqMVF6a2I4RkZoNDFk
QT09#:~:text=Malaysia's%20inflation%20rate%20in%20September,to%20August%2020
22%20(7.2%25).
V. Ong S. O. Govt steps to Control Basic Goods and Services Prices Stave off
Hyperinflation (2022, August 8) . Retrieved from
https://www.theedgemarkets.com/article/govt-steps-control-basic-goods-and-services-pri
ces-stave-hyperinflation-%E2%80%94-mof
VI. Official Portal Of Ministry Of Finance Malaysia. (2022, June 26). Total Subsidies In 2022
Nearly RM80 Billion, Highest in History. Retrieved from
https://www.mof.gov.my/portal/en/news/press-citations/total-subsidies-in-2022-nearly-rm
80-bln-highest-in-history-tengku-zafrul
VII. What is Fiscal Policy?. (2022, December 13). Corporate Finance Institute. Retrieved
from
https://corporatefinanceinstitute.com/resources/economics/what-is-fiscal-policy/
5.0 APPENDICES