After nearly two years of low consumer prices and falling producer prices, their steady rise in the first quarter of this year suggests that higher inflation and price shocks will once again test the resilience of households, businesses and the overall economy.
While consumer price inflation edged up 4.3 per cent in the first quarter, up from 1.7 per cent in the previous quarter and 3.4 per cent in the same quarter last year, the producer price index (PPI, which measures the selling prices of domestic producers), shot up by 10 per cent from three per cent in the previous quarter and negative 4.4 per cent in the previous year’s first quarter.
Meanwhile, the broadest measure of price changes for the economy, the gross domestic product (GDP) deflator, which fell by 0.4 per cent in 2015 before edging up to 1.9 per cent last year, is also pointing to the rising price pressures, with the fourth quarter of last year showing an increase of 2.8 per cent compared to average annual increase of one per cent over the last five years.
End of low inflation era?
Unless advanced economies are able to sustain higher growth, consumer price inflation in these countries will remain subdued and below the two per cent target. Consequently, their role as a part of the global factors contributing to inflation in developing economies will remain benign over the next few years.
Given ample global production capacity and supplies, the low inflation in advanced economies will end only when domestic demand surges more strongly.
Demand has been held down by persistent unemployment, ageing population, weak productivity growth, and cautious sentiment amid ongoing geo-political uncertainties.
Nevertheless, the more positive and synchronised growth globally that marked the start of this year is a healthy sign that global demand may be on a more sustainable upward trajectory that could herald a modest inflation environment.
Inflation trends in emerging economies
The low inflation phenomenon likewise characterised many countries in the developing world. Although there were bouts of inflation surges due to energy and food price shocks caused mainly by supply disruptions, the overall inflation rate quickly reverted to the mean for most countries.
So far, the fuel and food commodity shocks have proved to be transitory with the underlying inflation for most economies reverting to below historical trends. This low inflation persistence has been one of the key features of developed and developing economies compared with inflation performance in the past decades.
A major factor contributing to low inflation in emerging countries, including Malaysia, has been globalisation. The rise in globalisation has created positive incentives for policy makers to maintain prudent monetary and fiscal policies that kept inflation in check.
Similarly, trade openness has resulted in the decline of price levels as producers become more efficient. Cheaper imports also substitute more costly local goods and services.
The deepening of domestic financial markets likewise has enabled the economies to absorb larger trade balance deficits and surpluses, thereby reducing the effects of domestic supply and demand imbalances on prices.
How serious is the recent inflation surge?
The phenomenon of weak inflation persistence suggests that Malaysia’s above trend CPI increase in the first quarter is expected to taper off in the second half of this year and normalised to the two-three per cent level next year in line with expected decline in world oil prices.
The mean-reverting inflation behaviour is conditional upon stable inflation expectations whereby there are little knock-on effects on the broader array of goods and services in the economy.
The absence of second or third round price effects appears to be holding up as the underlying inflation as measured by the core inflation index thus far has remained well-anchored while demand-pull price pressures remains subdued.
On the contrary, the price pressures faced by domestic producers remain a concern, notwithstanding the fact that rising prices may also indicate better pricing power and top line sales performance for suppliers.
A closer look at the disaggregated prices shows that the increases were largely accounted for by the sharp rise in the prices of raw materials and intermediate products.
The profit margins of individual producers, therefore, will be determined by the extent their production is affected by the rise in input prices, the ability to pass through the cost increases and the benefits they can reap from higher production and productivity gains.
For consumers, the expected downtrend of headline inflation from April onwards is positive news, but offers little consolation to households facing stagnant wages or income.
For example, a three per cent annual inflation over five years will result in a 16 per cent decline in the real income or purchasing power if there is, no accompanying rise in nominal income.
While the total number of households facing stagnant wages continue to shrink, it is important that more targeted measures are in place to mitigate the negative effects of inflation even at low levels on the affected households.
This article first appeared in the New Straits Times on 19 May 2017. Modified by Low Wai Sern.
