Wednesday, 16 July 2008

Inflation Woe

This is a very short respond to oyster cove, whom asked about the problem of inflation in Malaysia two posts ago. As with other general concerns on inflation in Malaysia, it is often masked implicitly, and sometimes explicitly, with an accusatory tone towards the government. Understandable I guess, but it is useful to know the limit of what the State could and could not do when it comes to the current scenario.


Inflation - Supply Shocks

The problem of inflation currently is global, not local. It is not due to the doings of the State, say like in Zimbabwe. If anything, Malaysians have been shielded too long from these pressures, particularly on fuel prices due to populist measures. The inflationary pressures are external, and in some sense, transient (I am referring to inflation, not the prices - i.e., the increase in prices, and not the levels of price), and does not come from within.

Conventional monetary tools to handle supply-shocks are mostly ineffective, and the appropriateness of using monetary means to overcome supply-origin inflationary pressures is often questioned. Interest rate is a very blunt tool. We currently have a delicate problem, careless wielding of the tool might result in more damage than actually solving the problem.

So what can the State do? I can think of two things:

1) Do not make the matter worse - by succumbing to populist policies such as fiscally unsustainable subsidies, price and wage controls and other measures which are popular but economically disastrous.

2) Prevent secondary inflationary pressure - there is little the central bank can do for supply shock inflation, but there is a potential problem of spiralling prices due to the first round impact of the supply shock. Firms might increase prices irresponsibly beyond the first round increase in cost, leading to further increase in prices and wages and so on. The classic price-wage spiral situation, plus the embedding of inflation expectation which would be much worse than the current problem now. I talked about this from a different angle not too long ago. Interest rate can help to stop this demand-induced pressure, if executed appropriately.


Exchange Rate - Appreciation?


There is of course, the issue of why don't we just allow the exchange rate to appreciate to control the inflation problem? Well, the problem is a little more subtle. I can think of two issues:

1) Allowing exchange rate to appreciate implies that the ringgit is undervalued to begin with. Which could be or could not be true - which is difficult to assess. For example, undervalued relative to? Vis-a-vis major currencies? Major trading partners? Major trading competitors? Propensity of more short-term inflows than outflows?

Anyway, the thing is, the ringgit has been appreciating over the past few years - not in a straight line manner, but appreciating nonetheless. Very recently however, as in since the beginning of this year, the ringgit is not appreciating as fast as other relevant currencies. And I do not think it is due to constant interventions from the central bank - the evidence doesn't corroborate this view. I believe the current relative weakness of the ringgit has got to do with the relatively bad economic prospects of the country compared to other economies (on top of the already bad overall global situations). And I am talking about political uncertainties. Definitely not inviting money into the country, and investments being driven on hold. This naturally limits the upward tendency of the ringgit.

So, if the ringgit is not held down artificially, then you can't really 'allow' it to appreciate. And to artifically appreciate the ringgit is not entirely sustainable or cheap too.

2) Exchange rate movements have many repercussions, many conflicting in nature. For one, it affects trade and external sector-oriented investments. Malaysia's exports and imports are about 250% of GDP, and exchange rate is the 'price' of our trade. Overvalued exchange rate can be bad for our exports, as well as investments in the sector. This adverse impact is significantly more damaging than the relatively transient inflation problem, as the impact is long-term in nature. When the country's dominant sector is affected, it will drag the economy down. There is a whole lot more to say on this, but I will stop here - the point is, manipulating the exchange rate can be wrought with many unintended consequences.



So there goes - my short say on the issue. I guess the main point is that it is not something policy-makers can handle easily, and I can't see how they are intentionally making the situation worse than it is.

The politicians, on the other hand, are making things worse, with power struggle and petty controversies. I wish some of them would just grow up and govern. Really do not want to tell my kids that we are the generation that messed up the country.

Elanor

26 comments:

Shawn Tan said...

i think that the previous generation messed things up.. it's up to our generation to fix things..

as for the inflation.. can interest rate controls by the central bank help??

Anonymous said...

50% interest rate will curb inflation...to hell with growth...

oyster cove said...

Elanor,

As I mention many times, inflation will hit hard on the poor people.
The riches will take advantages to increase the selling prices of the products they sell. The business owners are making huge profit in the expense of underpaid their workers and yet took advantages of raising the selling prices.
The income gab between the riches and poors are becoming widening. I am not suprise when the widening gab will be soon near to country like India, China, Vietnam etc.

The goverment should introduce the minimum salary guide for each profession like what it practice in Australia. This guide should be review every year and taking into account of inflation effect or deflation effect. By doing so, workers are being proctected.

Sean said...

I think there is pro and cons of fixing a base salary for the worker. The opposition will said the market will determine the salary, not gov. as the business will be determined by the business proprietor.

We could not compare us(Malaysia) with Australia in the sense that we have more than 2 millions foreign workers and they have almost none. The businessmen there have no choice but to employ high salary workers from local. Another point I would like to raise is that Aus. workers have been moving up the value chain but we are not(sad to say so)

Anonymous said...

1)business proprietors determine the salary of workers = due to paying corruption and left with little cash to pay workers salaries

2)Malaysians workers not moving the value chain = due to NEP

AL said...

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Jeremiah said...

The question of whether the Ringgit is overvalued or undervalued depends on the free flow of supply and demand of the currency. To some extent, Msia's interest rate policy of fixinf the OPR at 3.50% has led to the Ringgit pulling back towards the RM3.3 level when offshore rates have risen.

Thus, is 3.50% a fair rate given the inflationary outlook and the fact that food subsidies can't be sustained?

Msia's reforms need to be broad-based: encourage local competition like Japan did with their automakers, dismantle monopolies and oligopolies, allow more infusion of soft capital into the services sector and invest in people's skills.

Minimum wage laws should be set according to productivity relative to overseas benchmarks and cost of living.

Anonymous said...

Thanks to your lead, ET, ...just read Prof. Mankiw's post on " how to prop up housing mkt. " and Greenspan's idea would more than stabilise prices .. I read it was that that skyrocketted prices of good location residential property in Singapore.

still lots of faculty committments keeping you busy, ET ?

regards,

feliz

Anonymous said...

Say Elanor, been a bit quiet here.

OBT said...

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novice101 said...

The way things are heading in our country it is sure unsettlting. Do you share my concerns :

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novice101 said...

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Help someone to help others, at the same time give recognition to one who have been selflessly helping others.

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novice101 said...

Sorry should be:

http://novice101.wordpress.com/2008/11/10/

Anonymous said...

dear Elanor,

wishing you Happy New Year and a wonderful 2009 ahead . . .

feliz

Lisa Lee said...

Sigh... everything costs so much these days. I used to think Malaysia had lower cost of living. Imported stuff cost so much. Sometimes even more than Singapore..

Only thing I can is cut down un-necessary expenses~

Bo said...

e l a n o r

happy new year and when are you going to update this place?

curious said...

Hi Elanor. Just stumbled across your blog. Very interesting. Any more recent posts? Very interested to see what you thnk of BN's takeover of Perak today. I'm doing some research on political struggles in (Malaysian)cities.Look forward to hearing from you

Goat said...

Hello Elanor,

While from the Macroeconomics Perspective it does make sense to remove fuel subsidies as I agree with what you said that it is ultimately "fiscally unsustainable."

Then again, we have also learned that what is good in the Macroeconomics level is not necessarily good from the individual's perspective. For example, we are always told to spend our way out of trouble, and this is in part, an element of Bush's disastrous $100 Billion Stimulus Package (with the bulk in tax cuts). {The generous tax cuts for the wealthy ones not withstanding} Eventually, it turned out that those who have obtained the tax cuts chose to save their money in banks. (Which at another perspective, is not bad since the financial institutions can use it for loans ; then again, IF ONLY the banks weren't saddled with toxic assets and consumer confidence isn't at its low ebb.)

Removing fuel subsidy will definitely increases the grouses among the Malaysian Public. (It is taken for granted. Tell Malaysians that fuel is reasonably cheap compared to other country and they still think that we should continue with the subsidy.)

Like all of us,politicians respond to incentives. (Which is why special interest groups who lobby politicians for things beneficial to them exists). I could see 2 problems if such proposal were to be presented
a) The government will face resistance internally
b) Politicians will be reluctant to vote on it

I suppose we need a leader who dares to do what is right instead of what that is politically expedient, then again, like what my friend says "Show me a politician who doesn't act out of expediency, and I'll show you someone who has never won in an election."

Perhaps such subsidy could be removed gradually? Let the pure-market mechanism come into play, and watch the "invisible hand" deliver the magic of the market.

It is time that Malaysians realise that petroleum won't sustain our dependance on it any longer. If you ask me, it is time to move into an era of fuel-efficient vehicles and alternative energy.

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zewt said...

Elanor... time to write again...

noob.intern said...

come on write something new

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