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May 07, 2005
The wheels of inflation go round and round, round and round
Its been nearly a year that I wrote about the creeping inflation in Malaysia. I am not an expert about inflation and its been a long time, since I had this subject in my studies, so take the next with a bit of salt and allow me to ramble along for a while.
Inflationary trends become more obvious in Malaysia - more and more traders demand price increases already. It will creep even higher, when the subsidiaries that are imposed on many products are phased out. Which will happen, and which is a good thing since all those subsidiaries distort the real picture of the market.
Until the subsidiaries are gone, Malaysia will have hidden inflation in , and sooner or later, the government, who is currently paying the price, won't be able to do so anymore.
We had inflation earlier - just go to the shopping malls and remember certain price levels of products with the price levels just a few years ago. When I arrived in Malaysia, back in 1993, prices for novels, for example, were about half of what they are now. But while we have high inflation in Kuala Lumpur, there is not much of an inflationary trend in Kelantan, for example, or Pahang, may be. Inflation trends can be geographically disbursed.
Inflation often occurs when demand for products is high, and shop owners are happy to follow demand, until an equilibrium is reached. Now, next time, you go to shopping malls in Kuala Lumpur and see the wave of shoppers entering the different shops, carrying loads of bags, remember, this is the demand that fuels inflation. It is also possible to look at the demand for property that still exists in many areas - this could create a bubble, but surely also fuels inflation.
Users might buy, because the products are perceived as cheap (and expensive for others), but what happens here is that inflation is fuelled further. The challenge here is that if consumers believe that their money is not much worth anymore (illusion), and they stop consuming, a country can actually head downwards - a different topic that I don't want to write about now.
Companies also import inflation into the country. Global demand for certain products, especially in the resource industry, i.e. steel, is extremely high - causing their prices to spiral to higher levels. On the other hand, there are the high oil prices. Those companies using raw materials in their production line, have to pay high for their usage. This, again, is putting pressure on their own margins, and it is not always possible to absorb those price pressures in their operations. Sooner or later, they have to pass the prices on to their customers. The current price increases on individual products in Malaysia is a result of this multiplier effect. One company increases prices, the next also increases and so on. The problematic part is that the multiplication effect increases towards the end of the chain - the consumer. To make it easy: When one company increases its prices by 1%, the next might do so by 3% followed by 4% and so on. This is an example, and I don't want to introduce the respective formula here. Clear is that in the end, we see a 10% increase at the fuel pumps, 15% at the Nasi Lemak trader and so on.
Inflation is necessary, as long as it stirs towards equilibrium - the cross between supply and demand - which is fluctuating and never 100%.
"Why do we need inflation? Inflation is necessary mainly to facilitate an adjustment in relative prices. As income grows, consumer preferences change. This tends to lift the prices of certain goods relative to others. While it is possible to have deflation in certain industries to allow prices to adjust, deflation is generally hard to carry out as a policy. In view of this, a certain amount of inflation tends to be tolerated. The need for a relative price adjustment is usually greater during a country's fast-growth phase when its economic structure is changing rapidly."
What can be expected next? I believe that the interest rates will go up, rather sooner than later. Inflation is fuelled by too much money in the market, and banks will have to make money more expensive, to instil control into the market. It will also lower GDP growth, since economic growth dampens, when demand for money declines, something that Jeff called Double Whammy. However, as long as GDP growth is above inflation, a real increase in wealth still is the outcome - the difference is called "after-inflation". Wealth loss is the result, if GDP growth is below inflation.
There will also be a drive by companies to reduce costs and to increase their operational efficiency. In order to do so, they will look at all factors - from expansion to hiring of new people.
There is much more that could be said here - inflation is a tough topic that is not easily understood, linked to many different areas, and hurts a lot of people in the short-term. I tried to highlight some issues, but surely, there is much more that could be added.
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inflation
Posted by Andreas at May 7, 2005 11:49 AM
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Comments
at least we know that the unemployment rate is low. if inflation is high, it means unemployment rate is low. haha. and i have to agree, interest rates increase because investment and especially government expenditure increases. this means the government has to pay for it. it'll lead to what u have illustrated in your GDP growth problem. problem then is that, the crowding-out effect my set in in which the government's intention of lowering its expenditure is met with the consumer's and producer's increase in consumption/investment.
ok, that's all just theory, high school economics was fun. hahahahaha. i love macroeconomics! woo!
seriously speaking, i felt the inflation when i came back from canada too. scary.. @.@
Posted by: Ivy at May 16, 2005 09:45 PM