Inflation And Oil Prices In Malaysia

Inflation And embrocate Prices In MalaysiaIt is observed that more than a decade ago, megascopic fossil anoint tolls were in the midst of $20 to $40/cask with its ups and downs throughout the late 90s. The damage went up slightly before dropping again by and by the 1997 Asian financial crisis. In the beginning of the 21st degree centigrade however, the m startary places started to boost to almost double that to the average treasure of $40. Volatility is high as by 2002 the place dropped back to about $20 right after the September 11 Attacks before surging up again almost immediately. It can be said that from 2003 onwards, the expense of crude anoint throughout the humankind began to fast ascend higher and higher oer the few course of studys till late 2006. This is mainly due to concerns on exhausting rock fossil cover-wells throughout the world, the transport US-Iraq war situation, OPECs stand on providing the world with limited submit with its reason to pres erve resources, increasing growth and dependance on consumption of crude embrocate in the world and more. All of these add into the weight and urgency that spiked conspiracy and panic into the industry, added that market players took advantage of the situation to further propel expenses into the sky.By 2007, the bubble for the US Sub-prime loan crisis burst and sent a shock wave that changeed cash flow in world economies with a deficit of funds. A temporary sharp drop occurred in the footings of crude oil. Within a terminus of just a year, speculators, players, investors and suppliers any contri only ifed a part to the defeat oil footing hike in human history. The price of just an average of $60 per barrel more than doubled to an unbelievable peak of $ cxl or more per barrel. This has sent the world oil prices scrambling to readjust its value in the market and also affecting every other industry associate to it. As quickly as it came, the prices of crude oil crashed back to about $40 per barrel in less than half a year. The crash was timed, compete and expected. However the damage has been done to the world economies affecting overall price increases and devaluation of currencies. The more open on crude oil a country is, the large the effect it has taken. In short, it is the citizens who suffer from these two back to back sub-prime loan and crude oil price hike crisis.From then since, the price of crude oil has lingered around $40 to $50 average for a term as economies embrace recovery before the price of crude oil resumed its steep climb on again. The climb hovered around $80 per barrel by early 2010. Up until recently, the price of crude oil continues to hang around $75. It is safe to assume that the 21st carbon modern crude oil prices would continue to be at least this value of $70 and above with the very simple reason of increasing enquire with decreasing supply.Comparing the prices back a decade ago and ignoring the price hike scenario, t odays crude oil prices in per barrel is twice as very much what was valued back in the year 2000. This just goes to show how much has changed in just a short span of ten years in this industry and provides a correct indicator of what the future of the petroleum industry holds for us. One thing is for certain, it is that the price for crude oil will continue to climb at an increasing valuate in the future unless a substitute for our heavy reliance on petroleum could be discovered in time. Otherwise, in that respect is only that much we can prep atomic number 18 ourselves and embrace the ever increasing cost of living linked so heavily back to our grave dependency on the core energy source of the modern world.Research objectiveThis look aspires to validate the public perceptions that the oil price hike does essentially affect pretentiousness. It will analyse the consumer price index ( consumer price index) in Malaysia that would be affected by the social movement in oil price b y world crude oil price. Thus, the objectives of this research are as follows(a) To determine the effect of spherical oil price shock on Malaysia flash locate.(b) To validate the theories and perceptions that oil price movements will affect consumerproducts and services, regardless of whether fuel is directly or indirectly used as main inputin the business operations and value chain.1.3 Significance of the researchThe outcome from this research will assist Malaysia government to formulate measures in time of economic turmoil due to oil price shocks which include fiscal and monetary policies. This will spur economic development and stabilizing inflation and unemployment station. On the other hand, this research helps management of companies in Malaysia to be sufficiently prepared for any recurrence of oil price crisis that will tinge heavily on the country economic. The companies would need to redirect their business personate in preparation for the economic crisis.Chapter 2 L iterature review2.1 IntroductionInflation influences the economic growth of a country including those developing, developed or so far underdeveloped country. High inflation tends to give negative perceptions on a country as it indicates increase in consumer products price and unemployment rate. We believe that oil price movement is the study cause of Malaysias inflation. Also, we are keen to discover whether corporeal following rate, real tack rate, and bills supply would cause more on inflation compared to oil price.2.2 Oil price and inflationDifferent researches on the oil price fluctuations had been conducted to discover its effect on certain country rescue performance. These findings contributed important decision making of macroeconomic variables which seek to cope with the hiking of petrol price. For instance, Hamilton (1983) lay out that there is significant correlation mingled with oil price movement and economic expansion. This is supported by Gisser and Goodwin (1 986) and also Brown and Yucel (2002), who identified that increase in oil price, will tend to retard economic growth. In addition, zestfulness et al. (2009) in recent research, found that oil price hike negatively decrease output and investment, while it increases inflation and saki rate in China. 1% increases of oil price is said to decrease the output by 0.38% 100% increases of oil price will increase 7.34% of Producer Price Index (PPI) in the very(prenominal) month and 11.33% in the following month (Tang et al. 2009). These findings supported our research question and objective on whether oil price hike is one of the major causes of inflation in Malaysia.In Malaysia, Saari et al. (2008) focused on the effect of local petroleum price on the cost production in agricultural and agro-based sectors. They found that if price of petroleum increases 90%, the cost of production for fishing, forestry and logging, and oil palm primary products industries would increase by 30%, 12% and 7 %. In our research, we right Saaris research by discussing several independent variables and its effects on overall cost of production.2.3 Other independent variables and inflationOther independent variables besides oil price may give high impact on Malaysias inflation. Turnovsky and Wohar (1984) found that the causality among cash supply and heart prices in US is earlier neutral from year 1929-1979. In Malaysia itself, empirical studies on inflation and money supply are relatively few. Masih and Masih (1998) discovered a unidirectional causality runs from money supply to inflation rate regardless of the lag structure. Recently, Tang (2004) re-investigated the causal birth and found that money supply leads aggregate price in Malaysia but there is no evidence showing direct causal effect runs from money supply to inflation over 1970-1998. The Fisher (1930) stated that nominal elicit rate should reflect movements in the expected rate of inflation. In his findings, there is no apparent relationship amid price change and interest rate in the short run. Correlation coefficient of -0.459 was obtained for British info and -0.289 for United State. This is supported by Lardic and Mirgon (2003) which convinced(p)ly validate Fisher effect on G7 countries for the period 1970-2001.Chapter 3 Theoretical Framework3.1 IntroductionWe are interested to investigate whether increase in oil price would actually cause inflation and if so, how much of this inflation is actually related back to rising of oil price Theoretically, an oil price increase is assumed to be related to causing inflation, most unremarkably among day-to-day items and activities such as transportation cost, food price, and other short term dealings. This research study is part of finding out the extent of inflation and hopefully to get a good estimation of how much relationship is there between a 10% rise in oil price contributing to inflation.Long term dealings should remain unaffected by short ter m price changes as it will require longer period of time for the inflation of price to kick in before its price increases. One such example would be college and school fees. In fact, a good representation of this theory that we could use would be the very recent 2007-2009 oil price hike which spark worldwide oil demand and price breathing out tremendously high yet pummeling to unbelievably low price per barrel. This has somehow contributed to how we came up with this idea for our research job as we are keen to chequer about rising oil price and its effect on inflation as a whole.3.2 VariablesTwo very important figures in this research project would be oil price and inflation. Oil price as the independent variable is a very volatile value to determine. We would be using global value in determining how much US Dollars/barrel for oil price, occasionally there might be some numbers in Ringgit Malaysia (RM) for local references especially the ballooning price hike for 2008 in Malaysia , but mostly would be converted into US Dollars/barrel to effectively study the effect of oil price versus inflation in a global scale.Y (inflation) = f (oil price, money supply, real interest rate and real fill in rate)Due to the record of the world economy and everything has a relationship with others, there is more than one independent variable besides oil price, including the total money supply in the market, the real transposition rate and the real interest rate. We will also study how each of these variables interact with inflation as well. Inflation would be the dependent variable in this research project. Inflation is calculated from the consumer price index (cost-of-living index) which comprises several categories (as shown in mesa 1).Table 3.1 Weights of the CPI by major categories in MalaysiaCategoriesWeights (%)Food and non-alcoholic beverages31.4Alcoholic beverages and tobacco1.9Clothing and footwear3.1Housing, water and electricity21.4Furnishings, household equipmen t and ordinary household maintenance4.3Health1.4Transportation15.9Communication5.1 sport services and culture4.6Education1.9Restaurants and hotels3.0Miscellaneous goods and services6.0Total100.0(Sources Department of Statistics Malaysia, 2010).3.3 ModelThe initial influence that was proposed is the Input-Output Price Model. It is proven in past researches that this model defines the relationship between oil price and inflation well enough. However, due to restricted resources and time as well as permission to accessible mystic data, there is only lead students could come up with. It is being suggested that we use a Regression Model towards our data for calculation purposes to support our findings in this research project. And we will only use past proven records of results from the Input-Output Model to verify theories that could come up in this research project.3.4 Expected directionIt is expected that oil price as well as the other independent variables such as money supply, e xchange rate and interest rate will exact some effect on inflation. An increase in oil price, money supply as well as interest rate is expected to positively affect inflation. While an increase in exchange rate however is expected to negatively affect the inflation rate.Y (inflation) = f (oil price, money supply, real interest rate and real exchange rate)(+) (+) (+) (+) (-)Chapter 4 Data and Methodology4.1 The dataThe data obtained is time-series data from year 2007-2009. Monthly data includes crude oil commodity prices that classified under world oil price. These data is extracted from the Organization of the Petroleum Exporting Countries (OPEC) and Bloomberg. In addition, monthly consumer price index (CPI) is obtained from the Department of Statistics Malaysia while the data of real exchange rate, real interest rate are taken from Bank Negara Malaysia (BNM) Monthly Statistical Bulletin.4.2 Research methodologyValadkhani and Mitchell (2002) applied the input-output price model to assess the petroleum price shocks on inflation and household expenditures in Australia. Similarly, Saari et al. (2008) examined the impact of petroleum price on costs productions by disaggregating the components in the costs production into three categories fishing, forestry and logging, and oil palm primary products industries. In the other hand, Hamilton (1983) used seven-variable vector auto regressions (VAR) system to identify the impact of oil price shock on U.S economy in year 1948-1974. Similarly, Marcelo S. (2005) used identified vector autoregressions (IVAR) to analyse the interaction between interaction between exchange rate and cost production. Masih and Masih (1998) employed the Granger causality test, modified Sims causality test and vector error-correction modelling (VECM) approach to examine the causality direction between money supply and aggregate prices in the Southeast Asia economies For Malaysia, they found that all causality tests are consistently implied that m oney supply (M1 and M2) Granger causes increase aggregate prices. Lastly, Mitchell-Innes H. A. (2006) used the same method (VAR) and vector error correction model (VECM) to prove that inflation and long-term interest rate moved in the same direction.4.2.1 Hypothesis testingIn our research, quantitative research (regression model) is applied as a method of digest and interpretation of observation data in influence to discover the strength of relationships between independent variables (money supply, real interest rate, real exchange rate, and oil price) and dependent variable (inflation). This statistical method starts with the collection of data which will be implied in regression model to verify null-hypothesis testing. Causal relationships are analysed by manipulating the factors to influence the phenomena of interest. Following is the research hypothesisHo Oil price is not one of the major causes of inflation from year 2007-2009H1 Oil price is one of the major causes of inflati on from year 2007-20094.2.2 Regression abridgmentIn order to verify the hypothesis testing above, regression analysis is applied in estimating the unknown parameters 0, 1, 2, 3, and 4 in the relationship, using the data on oil price, money supply, real interest rate, real exchange rate, and inflation rate.Y1 = 0 + 1X1 + 2X2 + 3X3 + 4X4 + where Y1 is the inflation rate X1 is the oil price X2 is the money supply (M1) X3 is the real interest rate X4 is the real exchange rate and is the variable representing all other factors that may have direct influence on inflation rate.In addition, coefficient of inclination is implied to identify the significance of independent variables (money supply, real interest rate, real exchange rate, and oil price) on dependent variable (inflation).R= (1/N)*(xi-x)*(yi-y)/(x*y)Results from the regression analysis and coefficient of determination test shall decide whether or not Null Hypothesis (Ho) will be accepted and reject Alternative Hypothesis (H1). Statistics, tables and graphs will be used to present the results of these methods.Chapter 5 Research findingsInitial AnalysisInitial findings are done based on the graph analysis to identify the relationship between dependent variable (CPI) and independent variables (oil price, money supply, real interest rate and real exchange rate). From the graph, we analysed and identified reasons of those variables fluctuations from year 2007-2009.Figure 5.1 kinship between CPI and Oil PriceFrom Figure 5.1, it can be observed that inflation has a steady rate of increase over the past three years while oil prices met with a steep increase and peaked at June 2008 before crashing low at December 2008. After that, the value of oil prices increases steadily again. a great deal of the fluctuation in the value of oil prices was caused mainly by human speculation and manipulation of the oil market where issues such as limited oil supply, on-going war, terrorism and the sub-prime financial crisis cau sed the price hike. Despite the high and low prices of oil per barrel around the world, inflation rate was not passing impacted.Figure 5.2 Relationship between CPI and notes egressFrom Figure 5.2, it can be observed as usual inflation rate steadily increasing over the years without much interference. However, money supply has been increasing as the gap between inflation and money supply is closing in together over the years. This could be mainly caused by the recent financial crisis which caused governments around the world to panic and quickly come up with programs to reduce the impact of the financial crisis which saw many going bankrupt.Programs are usually drawing up of hefty sums of cash to be spent by the government or distributed through ways as a mean to have people spend money to keep the economy of the country moving. Billions of dollars worth in bills and bonds are created and countries such as Australia and Singapore even had its government give out Christmas Bonus in cash to encourage their citizens to spend. There is also the usual routine of printing new money each year into the economy. All of these and more could have added up to the increasing rate of money supply into the economy.Figure 5.3 Relationship between CPI and Interest countFrom Figure 5.3, real inflation rate sees a steady increase as already mentioned however interest rates have a rather surprising pattern. This shock pattern can be observed at September 2007 when interest rates unawares spiked to almost double its usual rate from 3.60% to 6.61% in the difference of a month. There was not much effect on inflation rate but this could be due to time lag for it to have effect.Ironically, it was this same period that the sub-prime financial crisis really started to accumulate in a wider problematic scale. Much could be questioned on why did the interest rates spiked all of a sudden. Yet in the aftermath of the crisis, we are seeing a steady decline on interest rates around the wo rld. This is mainly because interest rates are being lowered now to help accelerate recover economies by providing cheaper access to funding. Typical, this low interest rate attraction was what started the bubble for this crisis in the first place back in the year 2001 right after the September 11 Attacks.Figure 5.4 Relationship between CPI and Exchange RateInflation rate is once again here, only seeing a slight peak when oil prices jumped over everyones expectations. There is not much to be said for inflation rate with exchange rate as they both(prenominal) seem to be almost a nice straight line on the graph. A closer look into Figure 5.4 however tells us that inflation rate has been increasing steadily over the years while on the other hand exchange rates have seen an increase and decrease over the years instead.Exchange rate has not seen much big movements. Reasons could be that exchange rates around the world are extra sensitive and its value will react accordingly with all ot her exchange rates to find its correct value thanks to rapid arbitragers. Another reason could be due to economies around the world encouraging lower exchange rates to increase trading among countries. This would help the weakened economies recover better.5.2 Empirical result and analysisTable 5.1 Mean and standard deviationMeanStd. DeviationNCPI109.7333.420636Oil Price69.7525.36836Money Supply888203.08871807.619636 concrete Interest Rate3.4600.6641036Real Exchange Rate3.428771.133273236From Table 5.1, the number of observation (N) represents sample size collected from year 2007-2009 (12 months x 3 years). Smaller sample size tends to increase variability of the distribution. N equals 36 which is larger than 30, hence the difference is negligible. We assumed that the distribution is prescript and represent the population.Table 5.2 Skewness and kurtosisNSumMeanSkewnessKurtosisStatisticStatisticStatisticStd. ErrorStatisticStd. ErrorStatisticStd. ErrorCPI363950.4109.733.5701-.116.393- 1.570.768Valid N (listwise)36From table 5.2, the skewness and kurtosis are -0.116 and -1.570. Negative skewness indicates that the distribution skews to the left. Meanwhile, negative kurtosis indicates that the distribution has shorter tail. Hence, we concluded that the data is not normal distributed and asymmetrical.Table 5.3 Variables coefficientsModelUnstandardized Coefficientsstandardized CoefficientstSig.95.0% Confidence Interval for BBStd. ErrorBetaLower BoundUpper Bound1(Constant)13.3259.1781.452.000-5.39232.043Oil Price.089.013.6646.812.000.063.116Money Supply3.911E-5.000.82111.267.000.000.000Real Interest Rate.445.369.0861.205.000.3081.197Real Exchange Rate-.716.509.6126.263.000-.898.834a. Dependent Variable CPIFrom Table 5.2, we can observe thatOil priceOil price has positive coefficient, indicating that this variable has positive relation with CPI.When oil price increases by USD1, the CPI will increase by 0.089% in one month on average, while other variables being constan t.The p-value for oil price is 0.00, which is smaller than the 5% level of significance used in the test.Money supplyMoney supply has positive sign of coefficient, indicates that this variable has positive relation with CPI.If the rate of money supply increases by MYR1, the CPI will increase by 3.911E-5% in one month on average, while other variables being constant.The p-value for money supply is 0.00, which is smaller than the 5% level of significance used in the test.Real interest rateReal interest rate has positive coefficient, showing positive relation with CPI.When interest rate increases by 1%, the CPI will tend to increase by 0.445% in one month on average, while other variables being constant.The p-value for exchange rate is 0.00, which is smaller than the 5% level of significance used in the test.Real exchange rateReal exchange rate has negative coefficient, indicating that this variable has negative relation with CPI.When exchange rate increases by 1%, CPI will decrease by 0.716% in one month on average while other variables being constant.The p-value for exchange rate is 0.00, which is smaller than the 5% level of significance used in the test.All independent variables have significant value (sig.) smaller than 0.05. This indicates that all variables represent large level of statistical significance in the model. Therefore, equation for the model would beCPI = 13.325 + 0.089 Oil Price + 3.911E-5 Money Supply + 0.445 Real Interest Rate 0.716 Real Exchange RateTable 5.4 Adjusted R squareModelRR SquareAdjusted R SquareStd. Error of the Estimate1.951a.904.8911.1281a. Predictors (Constant) Oil Price, Money Supply, Interest Rate, Exchange RateFrom Table 5.3, adjust R square is 0.891, indicating that all variables (oil price, money supply, interest rate, exchange rate) explain 89.1% of the variation in CPI. There is a strong positive correlation between the independent variables and dependent variable. Hence, it is considered that the variables fit close into the model and are more likely to predict CPIs movement.Coefficient of Variation (CoV) is calculated to evaluate models goodness of fit. From Table5.3, the standard error of the estimate is 1.1281. From Table 5.1, the mean CPI is 109.733. The calculation of CoV is as followCoefficient of Variation = (SE)/ (Mean Price) x 100%= 1.1281/ 109.733 x 100%= 1.028%The coefficient of variation of 1.028% indicates that the average forecast error is 1.028% of average CPI. The model is considered as good model as its CoV is lesser than 5%.Table 5.5 ANOVAbModelSum of SquaresdfMean SquareFSig.1Regression370.069492.51772.699.000a sleep39.451311.273Total409.52035a. Predictors (Constant), Exchange Rate, Interest Rate, Money Supply, Oil Priceb. Dependent Variable CPIHypothesisHo Oil price is not the major cause of Malaysia inflation from year 2007-2009H1 Oil price is one of the major causes of Malaysia inflation form year 2007-2009From Table 5.4, the significance value is 0.00 which is smaller th an the level of the significance (0.05). Therefore, the null hypothesis (Ho) will be rejected. Oil price is considered as the major cause of Malaysia inflation from year 2007-2009.Table 5.6 Correlation between CPI, oil price, money supply, interest rate, and exchangerate.CPIOil PriceMoney SupplyInterest RateExchange RatePearson CorrelationCPI1.000.145.857.400-.226Oil Price.1451.000-.052.188-.803Money Supply.857-.0521.000-.601.200Interest Rate.400.188-.6011.000-.193Exchange Rate-.226-.803.200-.1931.000Sig. (1-tailed)CPI..199.000.008.092Oil Price.199..381.136.000Money Supply.000.381..000.122Interest Rate.008.136.000..130Exchange Rate.092.000.122.130.NCPI3636363636Oil Price3636363636Money Supply3636363636Interest Rate3636363636Exchange Rate3636363636From table 5.5, it can be observed thatCorrelation between CPI and oil price is 0.145, indicating positive relationship between both variables.Correlation between CPI and money supply is 0.857, indicating positive relationship between both variables.Correlation between CPI and interest rate is 0.400, indicating positive relationship between both variables.Correlation between CPI and exchange rate is -0.226, indicating negative relationship between both variables.The largest Pearson Correlation coefficient is to be found between CPI and money supply, which is 0.857.The Squared Correlation figure of 0.735 (0.857) is smaller compared to the adjusted R of equation model, which is 0.891. Thus, the correlation between CPI and money supply does not show any signs of collinearity problem with the model.Since the biggest available coefficient between pairs of independent variables is not a problem, hence the equation model does not have multi-collinearity problem.5.3 DiscussionFrom the result, it is proven that oil price does influence the inflation fluctuations. Oil price has positive relationship with CPI at 5% level. USD1 increase in oil price tends to increase 0.089% of CPI. Oil price influences most of the cost of goods a nd services in the market including cost of production and transportation. As a developing industrial country, Malaysia relies heavily on the import of crude oil as source of energy. authoritative increase of oil price tends to cause hyperinflation and therefore effect the development of the country.The results show that other variables such as interest rate, money supply and exchange rate do influence the inflation rate as well. From the analysis, money supply has strong positive relationship with Malaysia CPI between years 2007-2009. Hawtrey (1923) stated that the public holds undue proportion of cash balances with respect to their income when money supply increases. Hence, they tend to increase the level of spending. This is proven by the Quantity Theory of Money. When essence of money in economy increases faster than the growth in the level of future output, this will increase the market price level and therefor