THE inflation rate for November stands at 1.5% – marking the lowest point compared to the same period last year, which recorded 4% inflation in November 2022 following a continuous declining trend since August 2022.
Overall, for 2023, inflation is expected to range between 2.5% and 3%.
Is a low or high inflation rate an absolute indicator of an economy in a good or bad state? Many are confused.
The inflation rate serves as a crucial economic indicator providing vital information. Accurate understanding is essential for assessing and planning economic policies.
The inflation rate should be evaluated contextually, taking into account the current economic status. For instance, during the East Asian economic crisis of 1997/98, Malaysia experienced a sudden fall in the ringgit’s value, and inflation soared to 5.3% in 1998.
Inflation also spiked to 5.4% in 2008 due to rising global food and fuel prices. Generally speaking, increased production costs are one of the factors leading to inflation in these episodes.
Conversely, during the Covid-19 pandemic crisis in 2020, business closures and movement restrictions caused a sudden drop in demand.
The inflation rate fell to a negative level of -1.1% in 2020. The inflation rate also dropped to a low of 0.6% in 2009, specifically due to a contraction in global demand following the global financial crisis.
In this context, inflation rates decrease due to a marked reduction in demand.
Since 1990, the average inflation rate has been 2.6% per year. Generally speaking, the inflation rate is positive, indicating that prices are continually increasing. It is only the rate of increase that changes.
Is the downward trend in the inflation rate since August 2022 something extraordinary or occurs rarely? The answer is no – since 2011, well before the Covid-19 crisis.
There have been four episodes of which a continuous decline in inflation rates is to be soon. A word of caution though – despite a decrease in the inflation rate, as long as it is positive, the average price level continues to rise. A low inflation rate does not necessarily mean a decrease in the cost of living.
This brings us to the question: is this low inflation rate of 1.5% good news?
To answer this, we must evaluate what causes the current episode of low inflation rates before concluding it as a piece of resounding news. Is this low inflation rate caused by a decrease in demand?
The Malaysian Institute of Economic Research (MIER) which conducts quarterly business conditions and consumer sentiments surveys had this to say: for the second quarter of 2023, MIER reported a decline in the consumer sentiments index and business conditions index.
Consumers and firms anticipated a bleak economic environment and therefore started to limit their respective spending. Simultaneously, the dampening of the global economy has shrunk the country’s trade balance from RM26.7 billion in March 2023 to RM12.4 billion in November 2023.
There is a possibility that low demand is driving the low inflation rate. If this is the case, then this is – definitely – not good news.
Is a declining trend an indicator of a good economy? If this interpretation is correct, does a lower inflation rate mean a better economy for Malaysians?
Or, in a more extreme scenario, will a negative inflation rate (known as deflation) benefit the rakyat? Is a declining trend a suitable macroeconomic goal that needs to be realised?
Indeed – a high inflation rate, one which exceeds the rate of wage increases, erodes the purchasing power of workers’ income. The value of money shrinks, resulting in an increased cost of living.
The obvious question that arises is: should we lower the inflation rate as much as possible – even to zero or negative territory? Would this reduction be good for the citizens and the nation?
In actual fact, an inflation rate that is too low faces the possibility of deflation (negative inflation), which is an economic danger zone. The Japanese economy, which has been trapped in deflation for an extended period, is often referred to by economists as something to be avoided at all costs.
Expectations of a continued downward trend in prices due to deflation will cause consumers to postpone their spending, leading to reduced demand. At the same time, firms will stop investing, and further contribute to a prolonged economic downturn.
Be careful what you wish for! Like blood pressure or the pressure of tyres, inflation either too high or too low, are both bad news. In essence, this is the Goldilocks principle, in which the ideal situation is having the “just right” amount of inflation as opposed to having too much or too little of it.
The inflation rate should ideally be positive and stable at a sustainable level, not too high and not too low, but in line with the country’s production capacity.
If the inflation rate falls below 1.5%, moving towards zero or negative territory, we should worry about being trapped in a downward deflation spiral.
Let us pray that we are not entering an economic twilight zone. – January 7, 2024
Samirul Ariff Othman currently serves as a senior consultant at Global Asia Consulting and has a background as a senior researcher at the Malaysian Institute of Economic Research.
The viewpoints articulated are solely those of the author.