Impact of Inflation on Malaysian Economy
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Question
How does inflation affect malaysian economy and what is the solution to this issue?
Answer
Inflation denotes an ongoing rise in the general level of prices quoted in units of money. Inflation thus means an ongoing fall in the overall purchasing power of the monetary unit.
The costs of high inflation
• Income redistribution – Rise in prices of essential commodities will affect the poor segment of the society as they spend a major part of their income on these goods. This will lead to increased inequality in the economy. The vast majority of Malaysian households (74%) earn less than RM6,000 per month. This group will be most affected by the rise of food prices (KRI 2014)
• Less saving – As people spend more to sustain their present standard of living, less is being saved. This will result in less loanable funds. However, Malaysians have limited savings and low income levels, they are heavily dependent on debts to finance their consumption
• Reduce export competitiveness – The cost of production will rise. This may trigger negative multiplier and accelerator effects on national income and employment.
• Boom and bust cycles
The harm is greater to the extent that the actual inflation rate differs from the anticipated inflation rate. Borrowers and lenders who expect higher inflation agree to a higher nominal interest rate so as to preserve the real interest between them.
Solutions
• Monetary policy – In 2014, Malaysia’s central bank raised its key interest rate to help temper inflation and rising consumer debt (Reuters 2014).
• Fiscal policy and direct controls– The Malaysian government controls prices and subsidises on a lot of essential items.
• Supply side policies – such as reduction in company taxes to encourage greater investment.
Malaysia is a relatively open economy, so inflation is also affected by events in the rest of the world.
References
KRI (2014) The state of Households. Khazanah Research Institute. Accessed online via: http://www.krinstitute.org/form_getfiledownload.aspx?id=6146b07e-504d-401e-a986-33e2a530d862&type=2
Reuters (2014) RPT-UPDATE 1-Malaysia c. bank raises rates to contain debt, inflation. Accessed online via: http://www.reuters.com/article/malaysia-economy-rates-idUSL4N0PL5YG20140710
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