Why
does inflation occur and the factors that are affect inflation rates
Inflation
occurs when there are changes in the demand and supply of goods and
services. If there is an excess of total spending beyond the
economy’s capacity to produce, the average price will increase as a
result of the increased demand for goods and services. Producers take the opportunity to raise the price to cope with the increase in demand and increase revenue. This inflation
is known as demand-pull inflation (McConnell, et al., 2012). Inflation can also be a result of
higher prices being charged on to the end-user. These higher costs
might have been caused by increased raw material costs or production
costs, or higher tax rates. This inflation is known as cost-push
inflation (Triami Media BV, 2009). The increase in price of goods and services caused by
demand-pull inflation and cost-push inflation will increase the
inflation rates and vice versa.
From
the survey that was conducted, 80% of the candidates understood the
term “inflation” and why does inflation occur.
How Inflation Rate is Calculated
The
main measure of inflation in Malaysia is the Consumer Price Index
(CPI), compiled by the Department of Statistics Malaysia.
Historically, from 1973 until 2013, Malaysia’s inflation rate
averaged 3.74% reaching an all time high of 23.90% in March 1974 and
a record low of -2.40% in July 2009 (Fedec, 2012).
To calculate
inflation rate, a wide range of prices of consumer goods and
services, known as the market basket, from retailers across Malaysia
are collected and recorded. The composition of the market basket is
based on spending patterns of urban consumers in a specific period,
example 2011-2012. The Department of Statistics updates the
composition of the market basket every two years so that it reflects
the most recent patterns of consumer purchases and captures the
inflation that consumers are currently experiencing. The rate of
inflation is equal to the percentage growth of CPI from one year to
the next. For example, the CPI was 104.8 in 2012, up from 103 in
2011. So the rate of inflation for 2012 is calculated as follows:
Rate of inflation= [(104.8-103)÷103]×100=1.75%
(McConnell, et al., 2012)
From the survey that
was conducted, only 2/3 of the candidates are aware of the inflation
rates in Malaysia.
The Effects of Inflation
The
CPI is used to adjust wages or salaries, pensions, and Social
Security benefits. The central bank uses these readings to determine
interest rates. For example, if the Bank’s Monetary Policy
Committee estimates the inflation rate to be over 2% in the next two
years or so, it might decide to increase interest rates to try to
subdue it. On the other hand, if it estimates the inflation rate to
be below 2%, it might decrease interest rates. Inflation is a crucial
factor when banks set interest rates for mortgages and saving
accounts (Davies, 2012).
Other than interest
rates, people’s purchasing power is also affected by inflation. If
people’s income increases less rapidly than prices, their
purchasing power decreases. But if their income increases with the
prices, their purchasing power will not be affected. Value of money
is also affected by inflation. The value of RM 1 now is very
different compared the RM 1 ten years ago (McConnell, et al., 2012).
People affected by
inflation are fixed-income receivers, savers, and creditors. Firstly,
people whose incomes are fixed notice their incomes fall when
inflation occurs. Example, landlords who receive lease payments of
fixed ringgit amounts will be affected by inflation as they receive
money of declining value over time. Secondly, savers are affected by
inflation because as price rises, the real value of an accumulation
of savings deteriorates. Of course, most forms of savings earn
interest. But the actual value of savings will still decline if the rate of
inflation exceeds the rate of interest. Lastly, creditors who lend
money will suffer a loss because of inflation. As prices go up, the
purchasing power goes down. So creditors get back the same amount of
money with lesser value (McConnell, et al., 2012).
Output also
decreases because of inflation. Cost-push inflation causes the prices
of goods and services to increase. As price rises, the quantity
demanded falls. Therefore, firms respond by producing less output (McConnell, et al., 2012).
What
the Government is doing to control the Effects of Inflation
The government needs
to control high levels of unpredictable inflation since it can
severely disrupt the economy, cause uncertainty in financial
decisions, and redistribute wealth unevenly. The tools they have
available are monetary policy, fiscal policy, subsidies, and various
controls on prices, tariffs and monopolies (Cedar Spring Software, Inc., 2004). “The government is
continuously looking for ways to rein in inflation to lessen the
burden on the people,” said Deputy Prime Minister Tan Sri Muhyiddin
Yassin. The government’s annual subsidies are RM457mil on sugar and
RM2bil on diesel and petrol (Star Publication (M) Bhd, 2012).
The government can
also curb inflation through the central bank, Bank Negara Malaysia.
Bank Negara Malaysia applies policies such as monetary policy and
fiscal policy. Monetary policy can control the growth of demand
through an increase in interest rates and a contraction in the real
money supply. Higher interest rates reduce demand by discouraging
borrowing by both households and firms and increase the rate of
saving. The rise in mortgage interest payments will reduce
homeowners’ disposable income and their ability to spend. Higher
direct taxes and lower government expenditure through fiscal policy
increase the rate of leakages from the circular flow and reduce
injections into the circular flow of income and will reduce
demand-pull inflation at the cost of slower growth and unemployment (Tutor2u Limited, 2013).
From the survey that
was conducted, 17 out of 30 candidates thought that the government
has been doing a good job to curb inflation.
Consumer Purchasing Behavior when Inflation occurs
An increase in
inflation means an increase in prices of goods and services. This is
bound to have an impact on the consumers’ purchasing behavior. The
increase in inflation affects whether or not a consumer is able to
afford the goods and services at a higher price. Inflation directly
affects the value of money because when inflation goes up, the value
of money goes down, and so does the consumer’s purchasing power.
Inflation especially affects consumer behavior when wages do not
increase to accommodate the increase in prices (Lee, 2013).
Consumers’
purchasing behavior when purchasing essential goods and services may
not change much because they need it to fulfill their needs. On the
other hand, consumers may be more cautious when spending their money
on products and services that they desire. To save costs, consumers
will start looking at alternative brands that offer the same product
at a cheaper price. Consumers may also turn to locally produced goods
instead of imported goods because local goods are cheaper.
According to the
survey that was conducted, 28 out of 30 candidates’ purchasing
power was affected by inflation.
According to an article on the The Star Newspaper, published on 17th April 2013, Malaysia’s
inflation rate rose by 1.6% in March 2013 from a year ago due to higher costs
of food and non-alcoholic beverages. The Department of Statistics Malaysia
reported that the CPI for March rose to 106.2 from 104.5 a year ago. The
increase was in line with consensus. “The index for food and non-alcoholic
beverages, and non-food products for March 2013 showed increases of 3.3% and
1.0% respectively as compared to the same month in 2012,” it said (Star Publication (M) Bhd., 2013). 
