According to the Malay Mail Online, the current inflation rate is historically low at about 1.8% after having peaked at 4.2% in February 2016. While economists stick to this statement, Malaysian citizens experience a different reality where prices are not just increasing moderately, but strongly. In order to enable you to understand such difference, it is important to learn the meaning of inflation and how it is calculated.
Why does money exist?
Initially, the economy was based on trade. For example, 1kg of bread could be traded for 2kg of rice. But what would someone with bread offer to his barber for a haircut? The barber would not be able to take, for example, 5kg of bread, as he would have no need for that amount of bread. Therefore, money was introduced to facilitate trade. Generally, money has 3 functions: medium of exchange to standardise trade, store of value as it is easier to store coins than kilograms of rice, and a unit of account to make calculations easier with a standardised base.
What is inflation?
Inflation means that the prices of goods and services generally increase, instead of the prices of a single good or service. If inflation occurs, the buying power of RM1 decreases which means that you can buy less with this amount of money.
In Malaysia, inflation is measured by a consumer price index (CPI). The index is calculated by taking price changes for a pre-defined basket of goods and services. As a next step, all price changes will be averaged and the result will be the CPI of a certain year. In Malaysia, the products inside the basket were determined by the 2014 Household Expenditure Survey, indicating that all items are used on a daily basis in Malaysia. In total, the Malaysian CPI includes 512 items of which 214 are food and beverages.
What awakes the inflation monster?
If inflation increases, salaries seldom increase directly by the same amount. People with lower incomes especially suffer from this development, as they won’t be able to buy as much. If there is too much money in any market, prices for goods and services will continue to increase as long as there is too much money. This effect can also be called the “Inflation Monster” because if the central bank were to put more money into the market, the inflation would continue to grow. If the central bank decreases the amount of money too heavily, poor people will suffer as well, as the prices will decrease by a fraction.
Takeaway: The inflation reflects the price level of a whole nation and a whole basket of goods and services. Therefore, it is not directly applicable to every single household as your individual basket could look quite different.
Is inflation really that bad?
According to the European Central Bank (ECB), consumer surveys often show, that people “feel” inflation to be higher than it is in reality. This feeling can be tracked down to a few human behaviours:
- Price increases catch our attention more than stable or declining prices.
- Price increases of products or services we use on a daily basis such as bread, petrol or bus tickets grab our attention more than other products. Therefore, we might think that inflation is higher than in reality because our assumptions are based on our personal, frequently used products.
- There are a lot of expenses that do not happen regularly such as holidays, cars or mobile phones. As a result, we are not checking the prices for these items regularly and might not be able to say if the prices for this particular item changed.
- Payments that are done by automatic bank transfers tend not to raise our suspicion for rising prices as they are directly debited from our accounts. We might not even notice small increases in prices.
- Inflation rates are annual but our memory goes back more than one year. As inflation is, up to certain point, helpful for growing an economy, we might be more negative than we should be. A healthy inflation of 2% yearly would add up to more than 20% in 10 years.
Takeaway: Do not let your gut feelings influence your objectivity. Try to take a step back and think about whether your assumptions or expectations make sense and are rational.
How does the central bank control the inflation monster?
As already mentioned, the central bank can influence the amount of money that is in the market. The instrument to do so is the interest rate at which banks can lend money from the central bank. If the interest rate is lowered, it is cheaper for banks to borrow money and as a result credits will become cheaper. Thereby, more money will enter the market and inflation will increase. The other way around, if the central bank increases the interest rate, banks need to pay more for lending money from the central bank. Prices for credits will increase, less money will be requested and inflation will decrease.
How to know if the Inflation Monster is chasing you
Create your own basket of goods and services you buy for your household. To keep it simple this could be rice, bread, and eggs.
Then calculate the total amount spend on these products in one year. For example:
Year 0: 10kg of rice x 10 x RM20 = RM2,000; 1kg of bread x 52 weeks x RM9 = RM468; 1 pack of eggs (12) x 12 months x RM6 = RM72 for an average Malaysian family, which sums up to RM2,540. Track price developments for the products you have put into your basket on a monthly basis.
Add up all yearly prices and do the steps 1 and 2 for the next two years. The current year will be your base year.
Year 1: 10kg of rice x 10 x RM19 = RM1,900; 1kg of bread x 52 weeks x RM11 = RM572; 1 pack of eggs (12) x 12 months x RM8 = RM96, which sums up to RM2,568.
Year 2: 10kg of rice x 10 x RM20.5 = RM2,050; 1kg of bread x 52 weeks x RM11 = RM572; 1 pack of eggs (12) x 12 months x RM8 = RM96, which sums up to RM2,718.
Compare the prices from years 1 and 2 with your base year. An increase would mean that the Ringgit is losing buying power and a decrease would mean that the Ringgit is gaining buying power.
Year 1: RM 2,568 / RM2,540 x 100 = 101.10%
Inflation Rate: (101.10 – 100) / 100 x 100 = 1.10%
Year 2: RM 2,718 / RM2,540 x 100 = 107.01%
Inflation Rate (107.10 – 101.10) / 101.10 x 100 = 5.93%
This would tell us, that the inflation in Year 1 was relatively normal, but the inflation in year 2 was relatively high and the Inflation Monster appeared. Especially for year 2 actions are needed as the value of your money is decreasing. Some tips to help you save money can be found here. Further advice on how to deal with the Inflation Monster has been put together here.
In conclusion, it could be possible that the Inflation Monster is awake. But often it is not as bad as you “feel”. One way of how to tame the Monster by yourself could be to lower your expenses.
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