FACULTY OF BUSINESS, ECONOMICS AND ACCOUNTANCY

UNIVERSITI MALAYSIA SABAH

MACROECONOMICS II
(BT21803) SECTION 1
SEMESTER 2, 2020/2021

GROUP ASSIGNMENT
PREPARED FOR:
DR. RAFIQ IDRIS

Hereby, we declare that the work contained in this assignment is our

own, except where acknowledgement of sources is made.

PREPARED BY:

Name Matric No. Signature

Jonathan Tan BB19110655 Jtan
Joudie Tala BB19110307 Joudie
Norfaezah Binti Dollah@Mohd.Amdu BB19110866 Norfaezah
Nuraini Binti Latif BB19110361 Nuraini
Shandra S Kennedy BB19110803 Sjamdra

SUBMISSION DATE: 11 JUNE 2021

 Contents

1.0 Introduction ..................................................................................................................................... 1

2.0 Literature Review ........................................................................................................................... 2

2.1 Introduction of the Chapter ....................................................................................................... 2

2.2 Literature Review ....................................................................................................................... 2

3.0 Methodology .................................................................................................................................... 3

3.1 Model Specification ..................................................................................................................... 3

3.2 ADF Unit Root Test .................................................................................................................... 3

4.0 Empirical Results ............................................................................................................................ 4

4.1 Unit Root Test Result.................................................................................................................. 4

4.2 Cointegration Test Result........................................................................................................... 5

5.0 Conclusion ....................................................................................................................................... 6

References .............................................................................................................................................. 7

Appendix ................................................................................................................................................ 9
 Effect of Inflation and Unemployment on Economic Growth in Malaysia

1.0 Introduction

Gross Domestic Product (GDP) is the total market value of goods and services produced within the
boundaries of countries in a year (Leamer, 2008, p. 12). Alexander et al. (2017) states that there are
three approaches to calculate GDP. The first approach is the expenditure approach where all spending
on final goods and services in an economy are sum up. There are five components in this approach
which are consumption, investment, government spending, export, and import. Thus, the expenditure
approach equation can be written as Y = C + I + G + X – M. The second approach is known as income
approach. Like the name suggest, this approach adds up all the income earned within a country each
year. Wages, rents, interest, and profits are among the important components in the income approach.
The third way to calculate GDP is by using the value-added approach where all the value added at
various stages of production are sum up.
Donovan (2015) defines inflation as the rate of change in prices. He states that because of the
law of demand and supply, prices of goods and services will change and fluctuate over time. Reserve
Bank of New Zealand defines inflation as the term used to describe a rise of average prices through the
economy. This indicates that the value of money is losing over time. The value of RM100 twenty years
ago is not the same as RM100 today because of inflation. While there are many implications brought
about by inflation, there are three that stood out the most. First, newly created money is injected into
the economy will spreads slowly to individuals’ cash balances which bid up prices. Those who receive
the new money units last will see their costs rise faster than their incomes compared to those who receive
the new money first (Bagus et al., 2014, p. 5). Second, inflation slowly destroy the future purchasing
power of saving because it eats up the investment return of savers. Thirdly, inflation causes credit
expansion which will distort interest rates and lead to more investments than there have been real
savings (Bagus et al., 2014, p. 6).
Another important issue in macroeconomics is unemployment. Unemployment can be defined
as the number of people who are available for work and are actively seeking work but cannot find jobs
(Abel et al., 2013, p. 5). The International Labour Organisation (ILO) has set a guideline to categorize
those who are in a labour market and those who are not in the labour market or unemployed. According
to the ILO guideline, there are three characteristics that categorize a person to be unemployed which is
(a) not working, (b) currently available for work and (c) seeking work. Byrne & Strobl (2004) states
that practical implementation of these guidelines is quite difficult because there is no way to classify
non-employed persons as either unemployed or out of the labour force. Additionally, there are three
main types of unemployment which is (i) structural unemployment, (ii) cyclical unemployment, (iii)
frictional unemployment. There are also other types of unemployment which is seasonal
unemployment, regional unemployment, and voluntary unemployment.
Definitions and meanings aside, this study will look into the effect of inflation and
unemployment on the economic growth of Malaysia from 1997 to 2020. We chose this title because we
are certain that the three variables that we chose, namely inflation, unemployment, and economic
growth are the “big three” in macroeconomics. We measure all the three variables in terms of rate.
Hence, inflation rate, unemployment rate, and GDP growth rate will be our main data. We obtained all
the data through the internet, mainly from the Department of Statistics Malaysia (DoSM) and some
other reliable sources such as the World Bank and Statista. In this study, we will try to find the best
answer for the following questions: How much does inflation and unemployment rate impact the
economic growth in Malaysia? What is the relationship between inflation and unemployment rate on
the economic growth in Malaysia? Based on the two research questions, we proposed that the objectives
of this study will be as follows:
(i) To measure the impact of inflation and unemployment rate on the economic growth in Malaysia.
(ii) To investigate the relationship between inflation and unemployment rate on the economic growth
in Malaysia.

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 The paper is organized as follows. In the next section, the related literature regarding the
relationship between inflation, unemployment, and economic growth in Malaysia and other countries
are reviewed. Subsequently, section 3 presents the model and method used in this study. Section 4
discusses the empirical results, and the last section concludes with the reiteration of the key findings.

2.0 Literature Review

2.1 Introduction of the Chapter

In general, inflation has been one of the most important issues over time. Many causes have contributed
to Malaysia's inflation during the last several years, it may be argued. These elements are either caused
by economic considerations or by external forces that are unrelated to the economy. Economic
considerations are further separated into monetary and non-monetary categories. The money supply is
one of the economic variables that generated inflation in Malaysia within the monetary variables
category. The previous research on this topic may be divided into two categories: studies that looked
into the problem using numerous nations as a sample and tests that used a single nation as a sample.
2.2 Literature Review

According to Barro (1995), he picked a sample of more than 100 nations from 1960 to 1990.
He came to the conclusion that if some characteristics of a nation are maintained constant, such as
education or fertility rate, there is a large negative association between inflation and economic
development. To be more specific, if average inflation rises by ten percent per year, real per capita GDP
will fall by 0.2 to 0.3 percent each year. Similarly, Bruno and Easterly (1995) found a 40% inflation
rate to be an indicator of inflation crises in their study of the drivers of economic development in 26
countries that had inflation crises between 1961 and 1992.
A research by Grimes (1991) found, based on data from 21 OECD nations expanding over a
27-year period, that even modest inflation is harmful to economic growth. Khan and Senhadji (2000)
attempted to determine if various nations had distinct threshold thresholds. Between 1960 and 1998,
they used 140 nations as their sample. Their findings revealed that for industrial nations, the inflation
barrier was 1 to 3% at which economic development slowed. In poor nations, however, this figure
ranged from 7% to 11%. Different investigations were undertaken with a sample of a limited group of
nations in contrast to these vast samples.
Malla (1997), for example, studied at two small groups of people, one from poor Asian nations
and the other from the Organization for Economic Cooperation and Development (OECD).
Surprisingly, the findings revealed that whereas inflation and economic growth have a substantial
negative association in OECD nations, the association between the two variables is minor in emerging
Asian nations.
Alexander (1997) rejected the premise that there is no relationship between inflation and real
growth, based on a limited sample of OECD nations, and concluded that inflation is strongly and
adversely connected to economic growth. Another research of this type looked at a group of four South
Asian nations, including India, Pakistan, Bangladesh, and Sri Lanka, to see if there was a link between
inflation and growth. The findings led to two major conclusions. First, all four nations had a long-run
considerably positive link between the variables under study, and second, inflation sensitivity to
changes in growth was stronger than growth sensitivity to changes in inflation (Mallik and Chowdhury,
2001).
The second school of research, on the other hand, used individual nations as a sample to
examine the relationship between inflation and growth. The Ordinary Least Square approach was used
to examine the relationship in the instance of Nigeria from 1981 to 2006. Inflation was shown to be
both positively and adversely connected to growth. As a result, the author determined that a 1% increase
in inflation will result in a 0.9% drop in economic performance (RGDP) (Moritala, 2011). Similarly,

2
Gokal and Hanif examined the situation in Fiji.Their findings revealed that the two variables had a
slight negative connection, with causation running one way from GDP growth to inflation (Gokal and
Hanif 2004). Another research confirmed that the two factors had a negative association. It was the
instance of Brazil, where Faria and Carneiro used a bivariate time series model to evaluate yearly data
from 1980 to 1995. (2001).
Samuelson and Solow (1960) studied the relationships between unemployment and inflation in
the context of the US economy and found that the two macroeconomic variables had an inverse
connection. Solow (1970) and Gordon (1971), who used macroeconomic data from both the pre-1970s
and post-1970s periods to demonstrate the presence of a negative trade-off connection between
unemployment and inflation in the United States, made an important addition to the study on the Phillips
Curve. Solow and Gordon's research has been dubbed the "Solow-Gordon confirmation" of the Phillips
Curve.
According to Robert Lucas (1976), a notable economist and proponent of the Chicago economic
school, the trade-off connection between unemployment and inflation may exist only if workers do not
anticipate policymakers to create an artificial scenario of high inflation mixed with low unemployment.
Alternatively, if employees anticipate significant inflation, they will seek a salary raise. High
unemployment and high inflation would coexist in such a scenario, contradicting the Phillips Curve
idea. The "Lucas criticism" of the Phillips Curve refers to this line of reasoning.
To reflect this newfound interest, King and Watson (1994) used postwar macroeconomic data
to investigate the presence of the Phillips Curve in the context of the US economy. The study's findings
substantiated the presence of a trade-off relationship between unemployment and inflation in the United
States. When long-run and short-run disturbances are removed from the data, the presence of an inverse
link between unemployment and inflation may be observed, as King and Watson (1994) pointed out.
Hogan (1998) used macroeconomic data from the United States from 1960 to 1993 to examine the
Phillips Curve theory. Although the classic Phillips Curve looked to over-predict the rate of inflation,
the study's findings showed the presence of a strong and negative association between unemployment
and inflation.

3.0 Methodology

3.1 Model Specification

This study will use a quantitative technique that uses mathematical and statistical measurement.
Quantitative analysis represent a given reality in terms of a numerical value. The data is gained from
the World Bank which is the inflation rate, unemployment rate, and Gross domestic product (GDP)
growth rate from 1997 to 2020. The model that is used in this study is as follow:
Y = β0 + β1inf + β2ump + ε
Where:
Y = GDP / Economic Growth
Inf = Inflation
Ump = Unemployment
3.2 ADF Unit Root Test

In statistics and econometrics, an Augmented Dickey-Fuller test (ADF) tests the null hypothesis that a
unit root is present in a time series sample. The alternative hypothesis is different depending on which
version of the test is used but is usually stationarity or trend-stationarity. A unit root is a stochastic trend
in a time series, which is also known as a random walk. If a time series has a unit root, it shows a

3
systematic pattern that is unpredictable. The ADF test is based on linear regression. Serial correlation
can be an issue, in which case the ADF test can be used. The ADF handles bigger and more complex
models.
The following are Hypotheses for this model:

H0: unit root test is present in a time series sample.

Ha: stationarity or trend-stationarity

The null hypothesis is a unit root is present in an autoregressive model while the alternative hypothesis
is different depending on which version of the test is used, but in this study, the hypothesis alternative
is stationarity or trend-stationarity.
3.3 Cointegration Test
Cointegration tests analyze non-stationary time series processes that have variances and means that vary
over time. This method is used to estimate the long-run parameters or equilibrium in systems with unit
root variables. The cointegration test that is used in this research is based on the Autoregressive
Distributed Lag Model (ARDL).
3.3.1 Autoregressive Distributed Lag (ARDL) Model
This model can assess models with structural breaks and causal relationships for variables in various
integration orders (Pesaran and Pesaran, 1997), It can also alleviate the autocorrelated errors problem
that the finite distributed lag model has. (Hill et al., 2008).
The following are the hypothesis for this model:
1. H0: λ1 = λ2 = 0, indicating the non-existence of a long-run relationship among variables.
2. H1: λ1 ≠ λ2 ≠ 0, indicating the existence of a long-run relationship among variables.

The hypotheses are evaluated by comparing the estimated result F-statistics of bounds test with two
critical bounds values for a given significance level which is the lower bound and upper bounds critical
values. The null hypothesis is rejected when the value of F-statistics is higher than the upper critical
bound, while the null hypothesis will fail to be rejected when F-statistics is smaller than the lower
critical bound (Pesaran et al. 2001). However, if F-statistics is between the upper and lower critical
bound, then the relationship between the variables will be undetermined in the long run.

4.0 Empirical Results

4.1 Unit Root Test Result

Variables At Levels First Difference

Intercept Intercept & Trend Intercept Intercept & Trend
GDP -5.1466** -4.9833** -8.3702*** -8.8144***
(0.0004) (0.0030) (0.0000) (0.0000)
INF -3.6166* -3.9281* -8.0230*** -4.9701**
(0.0135) (0.0274) (0.0000) (0.0036)
UMP -2.6991 -2.6766 -4.2960* -3.9528*
(0.0894) (0.2539) (0.0031) (0.0269)

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Table 1.0: Unit root test result
The table above shows the result of the unit root test for three variables namely, GDP growth rate,
inflation rate, and unemployment rate at levels and first difference. Both at levels and first difference
shows the result in intercept only and intercept and trend.
Three levels of critical value 1%, 5% and 10%. Number of “ * ” signs show that at how many
levels of critical values, variable is stationary. For example, at level of ADF test foreign exchange rate
(-3.6166*) variable is stationary at second levels of critical values.
Unemployment has a negative association with GDP, while inflation has a positive association
with GDP (Gandelman and Murillo 2009). Inflation has a negative impact on GDP and has a negative
relationship with unemployment. The Autoregressive-Distributed Lag (ARDL) model was also utilized
in this study to determine the long-term link between unemployment, inflation, and economic growth.
The unit root test determines if variables are stationary or not. To check the stationary, the
Augmented Dickey Fuller is utilized. The findings suggest that GDP achieved stationarity for both
intercept and intercept and trend at levels. Inflation and unemployment achieved stationarity only after
differencing it once for both intercept and intercept and trend. Because all of the variables are not
stationary at the same level, the Autoregressive Distributive Lag (ARDL) model was utilized in this
study.

4.2 Cointegration Test Result

Autoregressive Distributed Lag Model (ARDL) Bounds testing procedure is a powerful statistical tool
in the estimation of level relationships when the underlying property of time series is entirely I(0),
entirely I(1) or jointly co-integrated. Bound testing as an extension of ARDL modelling uses F and t-
statistics to test the significance of the lagged levels of the variables in a univariate equilibrium
correction system when it is unclear if the data generating process underlying a time series is trend or
first difference stationary.
The bound testing approach has several advantages. The first advantage involves the
applicability of the ARDL method, irrespective of whether the series are either I(0) or I(1). Two
asymptotic critical bounds are utilized in the ARDL method. If the obtained F-statistic value exceeds
the critical upper bound, the null hypothesis which claims a long-run relationship between the variables
would be rejected.
If the F-statistic value is below the critical lower bound, the null hypothesis cannot be rejected,
and the result is that there is no long-run relationship between the variables. If the F-statistic value is
between two critical bounds, no comments can be made.

Lower Bound Upper Bound

R 5% 10% 5% 10%
2 3.1 2.63 3.87 3.35

Model F-Statistics Inference

GDP Growth (Growth in 7.7684 Cointegration
Inflation and Unemployment)
Table 1.1 Bound test result

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 As the table shown above, F-statistics (7.7684) is greater than the critical value for the upper
bounds I(1). So, we can conclude that there is cointegration between the variables. It means that there
is a long-run relationship in the analysis is found. Therefore, we reject the null hypothesis that there is
no cointegration among the variables.

5.0 Conclusion

This study measures the impact of inflation and unemployment rate on the economic growth in Malaysia
as well as determining the relationship that inflation and unemployment have on Malaysia’s economic
growth from 1997 to 2020. In the introduction section, the definitions and explanations of the three
variables were discussed. In short, inflation is defined as the rise of average prices through the economy.
Unemployment refers to a situation in which people who are available for work and are actively seeking
job but unable to land a job. Economic growth is simply an increase in the production of economic
goods and services compared from a period of time to another.
In the literature review section, various past studies involving the three variables are reviewed
to unable us to grasp a bigger picture on this study. In the methodology section, the model used were
specified. Along with that, two statistical tests were discussed namely, the unit root test and
cointegration test. For the unit root test, we employed the widely known Augmented Dickey-Fuller test
while for the cointegration test, we used the Autoregressive Distributed Lag (ARDL) Model. After
running the test through EViews, the findings were discussed in the result section.
The result shows that GDP growth rate achieved stationarity in both intercept and intercept and
trend at levels. Inflation and unemployment achieved stationarity only after differencing it once. The
result of the Autoregressive Distributed Lag Model (ARDL) used for the cointegration test indicates
that there is cointegration among the variables which implies that a long-run relationship exists. This
was shown in table 1.1 where the F-statistics shown to exceed the upper bounds I(1).
Thus, it can be concluded that inflation and unemployment do impact the economic growth in
Malaysia. Unemployment exhibits a negative relationship with GDP growth while inflation proved to
have a positive relationship with GDP growth. This is consistent with what previous studies have found.
Therefore, any policies recommendations from previous studies can be utilized. Among them include
i) Providing more employment opportunity to mitigate the unemployment issue.
ii) Tighten contractionary monetary policy by reducing money supply within the economy by
increasing interest rates.
iii) Providing more education and training to help reduce the structural unemployment
especially for the youth and graduates.
iv) Controlling the population growth rate.

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 Appendix

Year Unemployment rate Inflation rate GDP growth

(%) (%) (%)

1997 2.45 2.66 7.32

1998 3.2 5.27 -7.36

1999 3.43 2.75 6.14

2000 3 1.54 8.86

2001 3.53 1.42 0.52

2002 3.48 1.81 5.39

2003 3.61 1.09 5.79

2004 3.54 1.42 6.78

2005 3.53 2.98 5.33

2006 3.32 3.61 5.59

2007 3.23 2.03 6.3

2008 3.34 5.44 4.83

2009 3.69 0.58 -1.51

2010 3.25 1.62 7.43

2011 3.05 3.17 5.29

2012 3.04 1.66 5.47

2013 3.11 2.11 4.69

2014 2.88 3.14 6.01

2015 3.1 2.1 5.09

2016 3.44 2.09 4.45

2017 3.41 3.87 5.81

2018 3.35 0.89 4.77

2019 3.32 0.66 4.3

2020 4.55 -1.13 -5.6

Table 1.3: Inflation rate, unemploymnet rate, GDP growth rate from 1997 to 2020 in Malaysia
Source : World Bank

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