DEFINITION OF INFLATION is a criteria of a continuous increase in the

general price level of all goods in an economy for a specific time period. It is
measured by the increased in CPI. The rate of inflation is measured by the rate of
increase of price index, CPI. High inflation is undesirable as it erodes the purchasing
power of money that causes a drop in real income (and thus a drop in an
individuals standard of living), the weakening of a countrys currency, and a decline
in long-term economic growth.

Inflation Rate = (CPI1 CPI0)

100

CPI0
Negative Inflation is Deflation
TYPE OF INFLATION are demand-pull inflation and cost-push inflation.
According to Fisher, demand-pull inflation is too much money chasing for too few
goods. It is the situation that aggregate demand is exceed the aggregate supply at
full-employment, thus causes to shortage of goods and price hike.
Fishers equation
MV = PT
where,
M = money supply
V = velocity of money in circulation
P = general price level
T = total transaction of outputs
V and T are assumed constant; therefore, increase in Money Supply, the Prices
will also increase thus create the inflation.

DIAGRAM 1: Demand-pull Inflation

Other than that, cost-push inflation is another type of inflation. It is caused by
the high rise in the cost of production. The cost increases can be caused by various
factors such as higher wage rate, larger profit mark-up, expensive raw materials
domestically or from imported sources, increase prices of intermediate (capital)
goods and higher taxes.

DIAGRAM 2: Cost-push Inflation

Inflation also may effects the production of goods increases. As the prices
increase, therefore the producer will take this opportunity to increase their
production to maximize profit. Other than that, savings depreciated in value which
equivalent to lower purchasing power of money. Deficit in balance of trade is
another effects of inflation. As the domestic price increases and it become less
competitive in the international market.

FISCAL POLICIES AND MONETARY POLICIES

The primary objectives of the Malaysian governments monetary and capital
control policies are to ensure stability in the ringgit foreign exchange rate so as not
to disrupt trade flows, and at the same time to maintain a steady and relatively low
interest rate to sustain economic growth.
The inflation rate in Malaysia increased from 2.7 per cent in 1997 to 5.3
percent in 1998 during the Asian financial crisis 1997. To recover the economy, the
government embarked on an expansionary fiscal policy. In July 1998, it unveiled a
fiscal stimulus package of RM2 billion which turned the budget from a surplus of 2.5
percent of GDP in 1997 to a deficit of 1.8 percent in 1998 and 3.2 percent in 1999.
During the Asian financial crisis, Malaysia faced a large depreciation of the
ringgit and massive capital flight, even though it raised domestic interest rates. To
stem this outflow and depreciation, the government fixed the value of the ringgit at
RM3.8 to US$1 to manage the impossible trinity problem. Therefore, this allowed it
to lower interest rates to stimulate the economy without worrying about capital
flight or currency volatility. When the economy started to recover in 1999, capital
and currency controls were gradually relaxed and finally removed. Besides that, the
level of interest rates had also decreased significantly. For example, in June 1999,
the base-lending rate was 7.24% as compared to an all time high of 12.27% in June
1998. It meant that the crisis had not recorded a higher impact in the inflation rates
in Malaysia. The consumer price index (CPI) increased from 2.7% in 1997 to a high
of 6.2% in June 1998.
Furthermore, Genberg and He (2009) argue that a monetary policy reaction
to the variables other than output and inflation should not lead to conclude that
monetary policy targets these variables. According to them, an inclusion of such
variables in the policy reaction function means that they carry information about the
future of inflation in the economy. For instance, a depreciation of currency may
require a contractionary monetary policy not because the central bank targets a
particular level of exchange rate, but simply because the currency depreciation may
lead to domestic inflation (Genberg and He, 2009).
Trade-off between Growth and Inflation The focus of macroeconomic
management has been on sustaining high growth by raising productive
investments. Price stability has been a key, but generally subsidiary goal. A tradeoff
between growth or employment and inflation has been presumed by policymakers
as the rapid growth of aggregate demand has led to cost and price pressures. Also,
as full employment is reached, labour demand pressures raise wages.
But despite then Prime Minister Mahathirs zero inflation rhetoric in the mid1990s, Malaysia has not been obsessed with checking inflation. Thus, when high
growth has brought about inflationary pressures, the authorities have not reacted
by engineering slow-downs, e.g. by raising interest rates. Actions to slow down the

economy have only been taken after exhausting efforts to reduce price pressures in
other ways. Policy instruments for managing the level and direction of investments
have generally been preferred to raising interest rates. Reducing inflation however
has costs in lost output and unemployment during the adjustment.

ISSUES AND CHALLENGES OF INFLATION ON OIL PRICES AND FOOD PRICES

Bank Negara stated in an issued statement that, while both the risks to
higher inflation and the risks to slower growth have increased, the immediate
concern is to avoid a fundamental economic slowdown that would involve higher
unemployment. Furthermore, cost-push inflation driven by supply shocks (a
leftward shift of short-run aggregate supply) limits the effectiveness of monetary
policy in reigning in inflation. The rationale is that reducing the money supply in the
market by increasing interest rates which is the cost of borrowing money would not
reduce international oil prices. The increase in oil prices will tend to retard economic
growth. In addition, it is found that oil price hike negatively decrease output and
investment, while it increases inflation and interest rate.
As seen from the previous findings the impact of the increase in oil prices on
GDP, and inflation, we can see that Malaysia faces an economic slowdown and high
inflation that would put pressures on the ringgit to depreciate. Bank Negara has also
recently chose not to increase the benchmark interest rate to maintain economic
growth and employment at the expense of a higher price level which prompted the
ringgit to depreciate further (refer to interest rate outlook). Contradicting the
monetary policy of Bank Negara, regional central banks are taking a tougher stand
against inflation by tightening monetary policy to strengthen their currencies (Yeow
Pooi Ling & Yvonne Tan, 2008).
Most notable of all is Singapore and China which are using currency
appreciation to control inflation. By strengthening the local currency, Malaysia
would have to sacrifice a certain degree of its export competitiveness to shield
domestic consumers against imported inflation. Though Malaysia is a crude oil
exporting country, it is also a net importer of food which in part due to surging oil
prices have spiked to record levels. To strengthen the local currency, the central
bank should increase interest rates. This would reduce the money supply in the
market, and partially shield consumers from imported inflation.
Due to the present of high inflation caused by the price hike in petrol, further
expansionary policies by the government would add to already mounting inflation
rates and expectations of inflation. Similarly, continuing the fuel subsidy would be
equally disastrous as it would result in a long-run shortage of fuel in the country.
like

It is a common misperception that countries blessed with natural resources

oil would result in higher economic growth prospects and higher

competitiveness against countries that are forced to spend large amounts of money
to import these resources. Yet as history has often proven to us, this is seldom true
and countries with natural resources are often plagued with a resource curse which
leads to corruption, wastage, and mismanagement of the economy. Topping the list
are countries like Russia and Venezuela that though are rich in natural resources are
plagued with economic mismanagement.
Amidst the financial crisis, the inflation rate increased from 2.7 per cent in
1997 to 5.3 percent in 1998 (SyarisaYanti, 2002). The increase in food prices was
the main reason for the rise in the inflation rate, as food items accounted for 34.9
per cent of the weight in the overall Consumer Price Index (CPI) basket. Increase in
the prices of controlled imported essential items such as sugar, cooking oil and flour
was roughly 20.0 per cent. The local trader has taking the advantages to increase
the price of good due to the reason of oil price increase. The value of ringgit has
turn down and lowering its value because of the local traders act. By increase the
price of good, the value that previously can buy good in certain quantity, has goes
down that only by the same good but in the less quantity than before.
In Indonesia, a second IMF agreement in January 1998 set out in more detail
a program designed to prevent an economic contraction, contain inflation to 20 per
cent in 1998 and move the current account from deficit into surplus. The agreement
specifically mentioned the elimination of support to the aircraft industry and the
National Car project, the restriction of the BULOG (Indonesia's food distribution
agency) trade monopoly on the import of rice, deregulation of domestic trade in all
agricultural products, including cloves (a major ingredient of Indonesian cigarettes)
and the dissolution of cartels in the important cement, paper and plywood
industries. The Government also agreed to phase out energy subsidies by gradually
increasing the price of fuel and electricity, but limiting price increases for kerosene
used for domestic cooking.
The most immediate and widespread effect of the economic crisis on the
people of Indonesia has been accelerating inflation. During the first half of 1997,
Indonesia was experiencing particularly low inflation (2.6 per cent), but the price
increases of the second half brought annual inflation for 1997 to 11 per cent,
compared with a rate of 6.5 per cent in 1996. Since the beginning of 1998, price
increases have accelerated still further to levels which threaten hyper-inflation.
Inflation for January and February 1998 was 20 per cent and estimates for annual
inflation for the coming year have ranged from 40-50 per cent up to 100 or even
200 per cent.(13) Prices have risen across most sectors, but the most severe
increases have been in critical areas such as food and other essentials. Food prices
increased by 30 per cent during January and February. During the last year, rice has
increased from 1800 rupiah per kilo to 3500 ($A0.36 to $A0.70 at April 1998
exchange rates) and cooking oil from 2000 rupiah per litre to 5500 ($A0.40 to
$A1.10). The price of protein sources such as eggs, soy beans and chicken are rising
beyond the reach of many low-income consumers.