Published in Astro Awani, BusinessToday & theSun, image by Astro Awani.
The decision by the Monetary Policy Committee (MPC), the independent sub-institution within the autonomous Bank Negara, to raise the overnight policy rate (OPR) by 25 basis points to 2.75 percent on November 3 can only eat into disposable income of the majority of Malaysians – perhaps what would be now the B70.
It comes at a time when the rakyat are still feeling the pinch.
The Department of Statistics (DOSM) recorded that Malaysia’s inflation rate reached 4.5% in September. So far, the highest was 4.7% from the preceding month, i.e., August. In turn, this marked an increase from 4.4% in July.
Then too, the hiked-up prices remain “sticky”. Hence, even when the inflationary pressure has eased, there’s no corresponding decline (which should, ideally, be the case).
This could be attributed to the rent-setting power of landlords who, more often than not, refuse to lower rental prices to protect their new margins, for example. Corruption as a way of life is another salient reason.
The inflation rate normally/typically comes down (as in disinflation) due to either the decline in costs (the opposite of “cost-push”) or demand (the opposite of “demand-pull”).
The principal cause of inflation in the Western economies today (as was the case the last time in the 1970s) has been energy-driven or related – oil in the case of the US or gas in the case of Europe (including UK).
Recently, the S&P reported that the highest earnings sector in the US is still the oil and gas companies. As mentioned by Reuters (“Energy shares shine again on Wall Street, lifted by earnings”, November 1, 2022), energy is the only sector of 11 S&P 500 sectors in positive territory so far for 2022. The stock market rally definitively reflects the earnings which have jumped by 120 percent compared to last year.
Energy and energy-related bills such as utilities and food (passed on by transport and logistical costs) continue to be the top drivers of inflation in the US for 2022, moving forward.
At the micro-level, “[g]asoline and power bills now account for about 34 [percent] of the monthly budgets for the lowest-earning consumers, up from 31 [percent] last year” (“Why Inflation Is Hitting American Households Like Never Before”, Bloomberg, June 9, 2022). The Wall Street Journal has highlighted how energy inflation isn’t only the highest but also the most persistent (“Energy Prices May Keep Inflation High for Years”, June 30, 2022).
On the other hand, to be fair, the Chicago Federal Reserve branch has pointed out that durable goods prices have played an outsized role in overall inflation (i.e., compared to Europe).
This “puzzle” can be partly explained by reference to what’s known as the “bullwhip” effect.
What it means is that a small shift (i.e., increase) in demand in the downstream (i.e., retail) sector – in relation to consumers – can amplify or cause a ripple effect of a large shift in supply and production in the midstream and, by backward extension, the upstream (i.e., demand for raw and semi-processed materials) within the supply chain eco-system.
It can transfer higher prices from one sector (sub-sector) – for durable goods – to another (as in the case of the semiconductors/microchips where there had been a surge in book orders by the electronics manufacturing sector to safeguard against logistical disruptions) and may cause fluctuations (as excess inventory leads to mark downs before reversion).
In short, the overall durable goods sector will still show inflationary pressure, nonetheless – analogous to the shuffling of reserve balances among banks in the interbank market (i.e., these aren’t “leaked out” to be loaned to retail customers – which is why quantitative easing or QE was never inflationary to begin with, among other things).
And in looking at the main components or contributors of inflation in the EU, energy remains the highest rate. According to Eurostat (October 31, 2022), for the month of October, energy’s contribution to inflation was at 41.9 percent. This was followed by food, alcohol & tobacco from a distant at 13.1 percent.
In short, profit gouging – cartels taking advantage of geopolitical tensions to drastically mark-up prices whether directly (price-setting power – even as oil companies prefer to sweat out pre-existing investments in oil rigs and also to “compensate” for lower earnings under the Trump years in the US) or indirectly (i.e., through the futures markets transmitting to the wholesale markets in Europe).
All this comes back to the classic mainstream economic concept of the Phillips Curve based on the wage-cost spiral – so that demand for higher wages lead to higher business costs which are then passed back to the consumers. In short, the Phillips Curve describes a cost-push situation.
Inflation is a complex phenomenon. As the Stagflation of the 1970s that was caused by the oil or energy crisis emanating from deliberate cuts in production by the Oapec (Organisation of Arab Petroleum Exporting Countries) cartel shows in response to Fourth Arab-Israeli War, the origins of inflation are normally unrelated to demand-side dynamics.
In turn, the Phillips Curve forms the basis for “identifying” (or determining) the Nairu (non-accelerating inflation rate of unemployment) in which it’s posited that there’s a point where the trade-off between (low/high) inflation and (high/low) employment reached its limit in the long-run/term. This is when the wage-cost spiral will have a chain effect, irrespective of the level of unemployment.
Critically, it’s also an implicit/tacit admission of the constraints of monetary policy in bringing inflation down (which could only “hope”, at best, to aim for price stability in the long-run, i.e., rather than focusing on the levels of employment).
The Nairu, therefore, coincides with the stable “natural rate” of unemployment (i.e., the “equilibrium” or “steady state” between inflation and employment levels).
Inflation only came down at a very high price/cost. Examples are the two Volcker recessions in the US, i.e., the 1980 (10.8 percent unemployment) and 1981-1982 (11 percent unemployment).
The ultimate aim (the “sub-text”) of monetary policy, therefore, that’s been touted as “success stories” is to inject deflationary pressures into the economy – in order to push down prices.
In the case of the UK, it’s now supported by fiscal policy levers in the form of across-the-board tax rises plus spending cuts (austerity) which we’re witnessing under the Sunak-Hunt duo (for an economy that’s now languishing, as it is, under the weight of high energy and energy-related prices). The pretext is, of course, to plug the GBP50 billion fiscal hole.
Ironically, for a ruling government that prides itself in the “sophistication” of the free-market tradition, this is a very crude form of tackling inflation – compared to the ordoliberal (social market economy) consensus in Germany.
In the final analysis, monetary policy can be deployed on the pretext that the problem is “demand-pull” when actually it’s “cost-push” in the first place. This means monetary policy can be an overkill – used in an excessive sense.
Whenever macroeconomic policies target inflation primarily by way of interest-rate setting, it inevitably meant loss of income and, therefore, yet weaker purchasing power for those on the lower rung of the socio-economic ladder (as can be seen from Reaganomics and Thatcherism).
The rich and the top percentile of society benefits from an even stronger purchasing power – from the lower costs and prices as well as stronger currency.
This is why using monetary policy to “discipline” inflation, or in the case of the MPC to achieve some degree of “normalisation” (consistent with price stability), is ineffective at the macro-level.
It increases government, private sector and household borrowing costs – set against the (current) context of a cost-push phenomenon which is easing and expected to ease.
Shipping costs have come down by at least 60% from their peak (in the September to November 2021 period), as per Statista 2022.
Net effect is that monetary policy would now be, unwittingly, taking over the role as the primary driver of inflation.
At the of the day, as long been advocated by EMIR Research, fiscal policy via taxation is the best tool to discipline inflation. Interest rates are a form of a long-term contractual “consumption tax”, whereas corporate and personal taxes are income-driven.
Taxation regulates demand (and also supply) in the economy on a targeted and precision-guided basis. It can either take the form of tax rises or tax cuts or even both together for the same target group to offset one measure against the other.
All this whilst simultaneously providing the government with the revenue to stimulate/pump prime the economy when the deflationary impulse approaches recession (without causing inflationary pressures in turn).
A survey conducted by Ilham Center, O2 Research and Huayan that’s published by The Star (among five media outlets) under the heading, “What the Rakyat Want” (October 30, 2022) show that the majority of Malaysians are concerned about the state of the economy (as exactly argued for a long time by EMIR Research, namely the tummy or perut economy).
For the poor people at the bottom of the socio-economic and economic pyramid, higher cost of living will push them deeper into the poverty. This means increased government spending on cash transfers and even subsidies even if there’s going to some form of rationalisation eventually – since the targeted recipient can only increase.
The previous and now caretaker government has admitted that there will be changes in the social classifications where the T20 and M40 will decrease and the B40 is expected to become the B60.
On the contrary, not only deflation but inflation also (i.e., either way) actually further enriches the rich – e.g., higher OPR results in higher interest rates which pushes up the bank’s overall earnings and, by extension, share prices and, therefore, the dividends.
Shouldn’t the cumulative OPR hikes, therefore, be off-set by a wealth tax and capital gains tax (CGT)? And a multi-tiered and special GST (should it ever be reintroduced)?
How about a windfall tax on banks?
The government has a political and moral duty to reduce the impact of inflation on the rakyat and, thus, ought to do more.
Farah Natasya is Research Assistant at EMIR Research, an independent think tank focused on strategic policy recommendations based on rigorous research.
