The economist expectation on inflation in Malaysia

Inflation in Malaysia is expected to remain low for the rest of this year due to weak exports and softer domestic demand. Malaysia is now experienced a deflationary pressure. Deflation is defined as a persistent fall in the average level of prices in the economy.

In this case Malaysia is categorised as having a “bad” deflation”. Bad deflation finds it source in the demand side of the economy. As the export trade and softer domestic demand is low due to lower oil and commodity prices, this will cause aggregate demand (AD) to decrease. A fall in AD will result in a decrease in the price level and a decrease in real output. Please refer to the diagram below.

Diagram 1: Decrease in AD due to weak exports and softer domestic demand in Malaysia.

Diagram 1 above illustrates the “bad” deflation situation. From the diagram above, we can see that AD shift to the left to AD1. A fall in the aggregate demand (AD) will result in a decrease in the price level from P1 to P2, and a decrease in real output from Y1 to Y2 .

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When there is less demand, businesses makes less profit or even loss. The producers need to cut down their cost of production by cutting down supply and lay off worker. Therefore, the level of unemployment will rise. This will affect economy badly.

If more people are unemployed, their real income is low, thus their purchasing power will decrease, there will be even less consumption. This is proven from the article where it state that consumer price index [1] (CPI) in Malaysia dropped from more than 8% inflation in 2008 to two consecutive months to – 2.4% in July 2009. This will lower the GDP (growth domestic product) level.

Furthermore, the amount of investment from investor rely highly on their expectation of the economy climate for the future, if the consumer demand showing no improvement in the future, business confidence is likely to be low. Investor will refuse to invest in our country. This has negative implication for future economic growth.

Deflation brought many impact on the producers, consumers and also the economy itself. In the situation of “bad” deflation, producer will faced with the risk generating low profit. This is because when the demand is low, it causes the price of product also low, they would not gain much profit and to ensure them not too loss too much, they will cut down the supply to increase the price back. They also tend to decrease the number of workers to save their cost of production.

The consequences, of the producer’s actions are faced by consumers. When they are fired, their real income will remain low, hence, could not buy good as much as they want. Its indicates their purchasing power is low. And this illustrates the standard of living also at low level.

Diagram 2: A decrease in AD and real output.

These situations affect the economy badly. As we can see, in the Diagram 2, when the demand decreases from AD to AD1, price will also decrease (from P1 to P2) resulted in decreasing amount of real output from Y1 to Y2. To survive, producers tend to lay out workers to cut down cost of production. The unemployment level will increase. In the economy it is not good to have high level of unemployment as it will lower down the society’s standard of living. Economic growth will decrease and economic development will be halted.

From the explanation above, Malaysia should take immediate action to overcome bad deflation problems. Government could take actions such as by increasing the demand from consumer and increasing the aggregate supply.

To increase AD, producers could promote their product by advertising or by giving a discount. The producer also could increase their workers income, as it can make them more motivated to works and produce high quality of product that meet the consumer’s taste. In a way, this could increase the aggregate supply (AS) as well. Government also could change to expansionary fiscal policy where it could encourage greater consumption by lowering income taxes to increase disposal income. Another way is by lowering the corporate tax so that firm could enjoy higher after-tax profit. The chances of them to lay off worker will be decrease. Therefore, the rate of unemployment will decrease. This is the best solution after all.

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ABSTRACT

This article is about the economist expectation on inflation in Malaysia. They expected that inflation in Malaysia to remain low. There are several factors that contribute to this condition. First, it is due to weak exports and softer domestic demand because of lower oil and commodity prices. This condition is called deflation. There are two category of deflation; “good deflation” and “bad” deflation. As one of the Asia country, Malaysia experienced “bad deflation”. A fall in aggregate demand will result in a decrease in price level and a decrease in real output. If real output decreases, then it is assumed that the level of unemployment will rise, as firms will need fewer workers if there is less demand. Asian country has come out with several ways to overcome this problem. However due to some weaknesses. Only one method, which is investment liberalisation, would be the effective method in order to revitalized Malaysia’s economy and helps increasing the inflation rate.