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UNIVERSITI PUTRA MALAYSIA
THE TRANSMISSION MECHANISMS OF INFLATION: AN EMPIRICAL STUDY ON THE ASEAN ECONOMIES
CHENG MING YU
FEP 1999 8
THE TRANSMISSION MECHANISMS OF INFLATION: AN EMPIRICAL STUDY ON THE ASEAN ECONOMIES
CHENG MING YU
DOCTOR OF PHILOSOPHY UNIVERSITI PUTRA MALAYSIA
1999
THE TRANSMISSION MECHANISMS OF INFLATION: AN EMPIRICAL STUDY ON THE ASEAN ECONOMIES
By
CHENG MING YU
Thesis Submitted in Fulfilment of the Requirements for the Degree of Doctor of Philosophy in the
Faculty of Economics and Management U niversiti Putra Malaysia
May 1999
SPECIALLY DEDICATED TO :
MY LOVE MOM AND DAD
& MY DEAR SISTERS: CHAIM YU, WEN YU, YEE YAR AND HOU YEA
& MY BROTHERS-IN-LAW: CHEN THONG AND SIM GUAN
ACKNOWLEDGEMENTS
My debts to many individuals can be warmly acknowledged but never fully
recompensed. I wish to express my deepest appreciation and profuse thanks to the
Chairman of my thesis committee, Dr. Tan Hui Boon, who provided years of
unconditional, personal support and encouragement, insightful suggestions and
guidance that made it possible for me to successfully complete this study. To her, I
owe a debt of gratitude.
An equal large debt is owed to the members of the thesis committee, Assoc.
Prof Dr. Ahmad Zubaidi, Assoc. Prof Dr. Mad Nasir and Assoc. Prof Dr. Zakariah,
thanks for their enthusiasm and valuable guidance and comments in the writing of this
thesis.
My thanks also go to lecturers in UPM for their direct and indirect assistance,
advice and support. Special thanks are due to Prof Dr. Ghazali, Prof Dr. Nik
Mustapha, Assoc. Prof Dr. Kuperan, Prof Mohd Yusof, Prof Ariff of Monash
University, Australia, Prof Annuar and Dr. Shamsher for their useful comments and
suggestions.
Special recognition is due to Dr. Ashley for his very useful comments during
the course of this study. An immense appreciation is also due to my uncle, Mr. Hank
Lee, economic specialist of American Institute in Taiwan and friend, Dr. Lin Chin
iii
Ming of APEC Study Center in the Taiwan Institute of Economic Research, who
greatly helped me throughout my work on this thesis with ideas, guidance and
continuous criticisms.
Thankful to the financial support provided by the Yayasan Sarawak Tunku
Abdul Rahman Foundation, who financed my entire education in the Ph.D. program.
Great appreciation is due to Puan Rabidah, Puan Zaiton, Puan Arbaiyah, Puan
Faridah, Puan Napsiah and all the staffs of the Graduate School for their helps during
the process of completing this thesis. Also to Kak Roby, the lab assistant of the
Faculty of Economics and Management, for her kindness to let me used the computer
facilities in the faculty.
To all my friends, especially Shu Ting, Law, Wai Kit and Meng Keat, Jo Ann,
Jahan, Taufiq, Huson, Ahmed, Indah, Amna and Ahlam not only for their help during
this study, but also for the personal warmth they have injected into this arduous
process.
My final and greatest debt is to my family - my dear mom and dad, my sisters
and brothers-in-law. The list of sacrifices they have made in order for me to complete
this study is long. Their support and love have been wonderful.
iv
TABLE OF CONTENTS
Page
ACKNOWLEDGEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . 111 LIST OF TABLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . YI11 LIST OF FIGURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x ABSTRACT . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Xl ABSTRAK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Xl11
CHAPTER
I OVERVIEW OF THE STUDY ........................... . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Geographic Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 The Study of the ASEAN Economies . . . . . . . . . . . . . . . . . . 2 The Study of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Statement of Problem . . . . . . . . . .... . . ... . . . . . . . .. . . .... . . . . . . . . 9 Objectives of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Significance of the Study . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . 14 Organisation of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
n THE ASEAN ECONOMIES . ... . . ... . .. . . . . .. . . . . . . . . . ..... 18 History and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Indonesia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Malaysia . . . . . . ..... . . . . . . ..... . . ......... . ...... . . ........ . . .. .. 38 The Philippines . . . . . . . .... . . . . . . .. . . . . . . . . .. . . . ..... . .... . ..... 44 Singapore . . . . . .. . . . . . . . . . .. . . . . .. . . . .. . . . . . . . . . . . . ...... . . . . . ... 48 Thailand .. . . . . . . . . .. . . . . . ..... . . ... . . ....... . ... ... . .... . . . . . . .. 56
ill THE STUDY OF INFLATION . . . . . . . .. . . . . . . . . . . . . . . . . . . . 64 Introduction ....... . . . ... .... . . .. . . . . . . . . . .... . .. . . . . . ... . ... . . . 64 Definition of Inflation .................. . . ...... . . . . . . ......... 64 Measurement ofInflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
The Laspeyres Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 The Paasche Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Indicators of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 The Consumer Price Index (CPI) . . . ..... ... . . . . . . . . .... 70 The Producer Price Index (PPI) . . . .. . . .... . . .. ... . . . . . . 7 1 The GNP Implicit Price Deflator ................ . . ........ . 72
The Nature and Causes of Inflation .. . . ....... . ........... . . 79
v
The Quantity Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 The Demand-Pull Theory ofInflation . . . . . . . . . . . . . . . ... 83 The Cost-Push Theory ofInflation ...... . . . . .. . . . . . . . . . 84 The Monetarist Model ofInflation . . . . . . . . . . . . . . . . . . . . . 86 The International Inflation Model ............. . . . . . ... . 87
IV REVIEW OF LITERATURE . . . . . . ... . ..... . .. . . . . . . . . . .. . . 92
v
VI
Review of Empirical Studies on Inflation . . . . . . . . . . . . . . . . . . 92 Review of Empirical Studies on International Aspects of Inflation . . . . . . . ... . . . ..... . .... . . . . . . .. . . . .. . . . . .. . . . . . . . . . . . . 104
METHODOLOGY .......................................... . The V AR Technique . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Introduction to V AR .................................... . Statlonanty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cointegration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vector Error Correction Model (VECM) . . . . . . . . . . . . . . Causality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impulse Response Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variance Decomposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Empirical Models and Estimation Procedures . . . . . . . . Model Specification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Estimation Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diagnostic Checking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Price Index (LF) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Money (LM) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest Rate (IR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (L Y) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Private Consumption (LC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Government Expenditure (LE) . . . . . . . . . . . . . . . . . . . . . . . . . . Exchange Rate (LX) . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade Balance (L T) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital Inflows (LK) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Rest of the ASEAN's Inflation (LAF) . . . . . . . . . . . . The Rest of the World's Inflation (LWF) . . . . . . . . . . . . . .
RESULTS AND DISCUSSIONS ......................... . Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Estimated Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Unit Root Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cointegration Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
vi
1 17 1 18 1 18 12 1 127 136 1 39 146 148 149 1 50 1 58 163 165 167 169 169 170 170 170 171 171 171 172 173 174
175 176 179 180 187
Vector Error Correction Modeling (VECM) . . . . . . . . . . 192 Diagnostic Checking . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
vn SUMMARY AND CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . 242 Discussions and Implications of the Findings . . . . . . . . . . . . . . 246 Suggestions for A More Effective Inflation Management in ASEAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... .. 256 Limitations of the Study and Recommendations for Further Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258
BmLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . 260
APPENDIX A The Interpolation Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277 B The Seasonal Scalling Factors . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278 C The Graphic Presentation of Time Series . . . . . . . . . . . . . . . . . . . ... . 280 D The Residuals Correlation Matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
VITA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288
vii
Table
2. 1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
3.1
3.2
3.3
3.4
3.5
6. 1
6.2
6.3
6.4
6.5
LIST OF TABLES
Page
GDP Per Capita (US$) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Intra and Inter ASEAN Trade (US$ million) 22
The Compositions of ASEAN Imports and Exports (million US$) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Basic Economic Data for Indonesia . . . . . . . . . . . . . . . . . . . . . . . . 37
Basic Economic Data for Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . 43
Basic Economic Data for the Philippines . . . . . . . . . . . . . . . . . . 49
Basic Economic Data for Singapore . . . . . . . . . . . . . . . . . . . . . . . . 55
Basic Economic Data for Thailand . . . . . . . . . . . . . . . . . . . . . . . . . . 60
The Weights ofCPI by Major Categories in Indonesia . . . 75
The Weights of CPI by Major Categories in Malaysia . . . . 77
The Weights of CPI by Major Categories in the Philippines . . , 78
The Weights of CPI by Major Categories in Singapore . . . 78
The Weights ofCPI by Major Categories in Thailand . . . . 79
Lag Lengths Selection, Constant, Trend and Seasonal Dummies Determination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179
Unit Root Test Indonesia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182
Unit Root Test Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183
Unit Root Test The Philippines
Unit Root Test
184
Singapore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185
viii
6.6
6.7
6.8
6.9
6. 10
6. 1 1
6. 12
6.13
6. 14
6. 1 5
6 . 16
6 . 17
6. 18
6 . 19
6.20
Unit Root Test Thailand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186
Johansen Cointegration Analysis for CPIs of Five ASEAN Countries (Model One) . .. . . . . . . . . . . . . . . .. . . . . . . . . . . . 189
Johansen Cointegration Analysis for CPI of Each ASEAN Country and The Rest of the World (ROW) . . . . . . 190
Johansen Cointegration Analysis on Model Three 19 1
Estimated V AR Coefficients in VECM Model Indonesia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Variance Decomposition Indonesia ................ . . . ....................................... . ....... . . . 202
Estimated V AR Coefficients in VECM Model Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
Variance Decomposition Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1 1
Estimated V AR Coefficients in VECM Model The Philippines . . . ... ..... . . . . . . . . . . . . ... . . . . . . . . . .. . . . . . . . . . . . . 218
Variance Decomposition The Philippines ....... . . . . . .......... . . . . .... . . . . ....... .. . .. . . .... . .. . . . . . 220
Estimated V AR Coefficients in VECM Model Singapore . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
Variance Decomposition Singapore ....... . . ......... . . . . ....... . ... . . . .. . . . . .... . . ... . . .. . ........... . 228
Estimated V AR Coefficients in VECM Model Thailand .. . . . . . . ... . . . . . . . .. . . . . . . . . . . . .. . . . . . . . ' " ' " . . . . . . . . . . . 233
Variance Decomposition Thailand .... . . . . . ..... . . . . . . ...... . . . . . .. . . . . . . . . . ... . . .... . . . .. . . . . . . . . . . . . . . 235
Results of Diagnostic Checking on VECM . . . . . . . . . . . . . . . . 239
ix
LIST OF FIGURES
Figure Page
2. 1 GDP Growth Rates and Inflation Rates for the ASEAN Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . 61
6. 1 The Causal Relationships with Inflation Variable Indonesia . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
6.2 Response to one S .D . Innovations Indonesia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . . . . . . . . , . . . . . . 203
6.3 The Causal Relationships with Inflation Variable Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . . . 210
6.4 Response to one S .D. Innovations Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 12
6.S The Causal Relationships with Inflation Variable The Philippines . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 2 19
6.6 Response to one S.D. Innovations The Philippines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 1
6.7 The Causal Relationships with Inflation Variable Singapore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ' " . . . . . . . . . . . . . . . , . . . . . . 227
6.8 Response to one S.D. Innovations Singapore . . . . . . . . . . . . . . . . . . . . . . . . . . ' " . . . . . . . . . . . . . . . . . . . . . . . . . . 229
6.9 The Causal Relationships with Inflation Variable Thailand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ' " . . . . . . . . . . . . . . . . . . . 234
6. 10 Response to one S.D. Innovations Thailand . . . ... . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . . . 236
6. 1 1 The CUSUM Test Results for the ASEAN Economies . . . . 238
x
Abstract of dissertation presented to the Senate ofUniversiti Putra Malaysia in fulfilment of the requirements for the degree of Doctor of Philosophy.
THE TRANSMISSION MECHANISMS OF INFLATION: AN EMPIRICAL STUDY ON THE ASEAN ECONOMIES
By
CHENG MING YU
May 1999
Chairman: Tan Hui Boon, Ph.D.
Faculty: Economics and Management
Maintaining low and stable inflation has been the primary goal of most
countries, particularly for the fast growing developing countries. Vast great inflation
theories, from Classical, Keynesian, Monetary to Structural, carrying different
banners and offering different evidence on the causes of inflation. It is of utmost
importance to correctly identify the causes of inflation in each economic setting as
wrong diagnosis of the nature of the problem will lead to the application of
inappropriate cures that might hurt the economy.
This study, whenever possible, takes the effort to capture the ideas of major
inflation theories in a single dynamic inflation model. An eleven-equation set up with
eleven variables in each equation is used for each five ASEAN countries. The
ASEAN in this study refers to five original members of ASEAN, namely fudonesia,
Malaysia, the Philippines, Singapore and Thailand. The primary mission of this study
is to analyze the relative importance of factors that significantly contributed to
xi
inflation in each of the ASEAN country. This study also aimed to examine the
existence of international as well as intra-ASEAN transmission of inflation to these
countries.
The objectives of the study were achieved by the estimation of Vector Error
Correction Model (VECM) and the analysis of impulse response function as well as
variance decomposition for each country. The data for the study consists of quarterly
observation from 1973:1 to 1 997 :11.
The results of the study revealed that for the ASEAN economies that showed
high and stable economic growth for a sustained period, namely Singapore and
Malaysia and which had adopted consistent policy in the country, tended to have
relatively low and stable inflation rates. Due to the openness of the countries, external
factors such as the rest of the world's inflation rates and the rest of the ASEAN's
inflation as well as the exchange rate variable are relatively more important in
explaining inflation in these two countries. On the other hand, Indonesia and the
Philippines which were burdened by huge foreign debts and had took up inconsistent
policy mix to spur the growth in the economy had generally experienced high and
variable inflation rates. External and internal factors are important in generating
inflation in these two countries. In Thailand, the inflationary analysis was somehow
unsteady. The findings could be attributed to the structural shifts arising partly from
trade and financial liberalisation in the country, particularly at the end of 1 980an.
xii
Abstrak disertasi yang dikemukakan kepada Senat Universiti Putra Malaysia sebagai memenuhi keperluan untuk ijazah Doktor Falsafah
MEKANISASI PENGANTARAN INFLASI: SATU KAJIAN EMPIRIKAL BAGI EKONOMI-EKONOMI ASEAN
Oleh
CHENG MING YU
Mei 1999
Pengerusi: Tan Hui Boon, Ph.D.
Fakulti: Ekonomi dan Pengurusan
Mengekalkan inflasi pada tahap yang rendah dan stabil adalah tujuan asas bagi
kebanyakan negara, terutamanya bagi negara yang pesat membangun. Terdapat
pelbagai jenis teori inflasi, dari Klasikal, Keynesian, Kewangan ke Struktur,
membawa bana yang berlainan dan menawarkan bukit yang belainan bagi sebab-
sebab berlak.unya inflasi. Usaha-usaha bagi mengesahkan asas inflasi dengan betul
bagi setiap ekonomi adalah amat penting kerana diagnosi yang salah tentang asas
masalah inflasi akan membimbing kepada penggunaan cara pembetulan yang tidak
sesuai yang mungkin mengancam pembangunan ekonomi negara.
Kajian ini, apabila sesuai, mengambil usaha untuk merangkumi idea-idea
inflasi utama ke dalam satu model inflasi dinamik. Satu sistem yang terdiri daripada
sebelas persamaan dengan sebelas pembolehubah dalam setiap persamaan telah
dibentuk bagi setiap lima negara ASEAN. ASEAN dalam kajian ini merujuk kepada
lima ahli asas, iaitu Indonesia, Malaysia, Filipina, Singapura dan Negeri Thai. Misi
xiii
utama kajian ini adalah untuk menganalisa kepentingan relatif faktor-faktor yang
menyumbang kepada inflasi di setiap negara ASEAN. Kajian ini juga bertujuan
untuk memeriksa kewujudan pengaruh-pengaruh antarabangsa dan ASEAN di
negara-negara 1ll1.
Objektif-objektic kajian ini dicapai dengan menganalisa VECM 01 ector Error
Correction Model) dan fungsi tindakbalas impuls dan juga dekomposasi variasi. Data
yang digunakan terdiri daripada data suku tahunan dari 1973:1 ke 1997 :TI.
Keputusan analisa menunjukkan bahawa negara ASEAN yang mengalami
pembangunan yang pesat dan stabil untuk jangka masa yang panjang serta
mengarnalkan polisi yang konsisten, iaitu Singapura dan Malaysia, cenderung
mempunyai kadar inflasi yand lebih rendah and stabil. Disebabkan oleh kebukaan
ekonomi bagi kedua-dua negara ini, faktor luaran seperti inflasi dunia dan inflasi
negara ASEAN lain dan kadar tukaran wang adalah lebih penting dalarn menerangkan
inflasi di kedua-dua negara ini. Di sebaliknya, bagi negara yang dibebankan dengan
hutang luaran yang tinggi dan telah mengarnalkan polisi yang tidak konsisten untuk
merangsangkan pembangunan negara, Indonesia dan Filipina secara keseluruhannya
mengalami kadar inflasi yang lebih tinggi dan tidak stabil. Faktor-faktor luaran dan
dalarnan adalah sarna-sarna penting bagi negara-negara ini. Di Thailand, analisa
inflasi adalah tidak stabil. Ini adalah disebabkan oleh pembangunan ekonomi yang
tidak stabil akibat daripada peralihan struktur pada akhiran 1980an.
xiv
CHAPTER I
OVERVIEW OF THE STUDY
Introduction
The Geographic Coverage
The ASEAN1 is currently comprising of ten countries, namely Indonesia,
Malaysia, the Philippines, Singapore, Thailand, Brunei and lately of Vietnam,
Myanmar, Laos and Cambodia which are all on the southeastern rim of Asia.
However, the focus of this study will be on the major, fast growing and dynamic
developing countries in the ASEAN, which consists of the economies of Indonesia,
Malaysia, the Philippines, Singapore and Thailand . Other members of ASEAN will
not be considered because of the lack of economical statistics and/or prominent
economics performance during the period of study . For the sake of convenience and
consistency, unless otherwise stated, the "ASEAN" in this study refers to these five
main economies in ASEAN, namely Indonesia, Malaysia, the Philippines, Singapore
and Thailand.
The ASEAN (Association of Southeast Asian Nations) was establish in 1 967 to enhance the cooperation among member nations.
I
2
The Study of the ASEAN Economies
The ASEAN economies have been the centre of the study because these
economies have undergone dynamic changes in their economic structure as well as
pattern of economic growth for the last three decades. Also, these countries cover a
fairly large range of average inflation rates in the sample period, which varies from a
low level of four per cent in Singapore and Malaysia to over ten per cent in the
Philippines and Indonesia.
Several ASEAN econOlmes have displayed strong capacity of dynamic
growth, with many having experienced high growth for a sustained period, such as
Singapore and Malaysia, which have continually maintained an average growth rate of
over seven per cent for the period between late of 1 980s and mid- 1990s . In general,
the growth per capita GDP averaged over four per cent in the ASEAN countries
between 1 970 and 1 996, compared with less than two per cent in other developing
economies and 2.6 per cent among the industrial countries (World Development
Report, 1996).
Rapid and significant increased in the interdependency among the ASEAN
economies and the rest of the world in the form of trade, investment, capital and
technology co-operation have led to the strong growth performance in the region.
Efforts to improve the macroeconomics environment in addition to trade and financial
liberalisation have brought about a closer link between these ASEAN countries and
3
also the linkages between ASEAN with the rest of the world. As a consequence,
domestic economical policies have become more interrelated with external sector
policies . Therefore, it is more appropriate to analyse the domestic macroeconomics
problems in these countries in the context of open economy instead of closed and
isolated economy as had been done in most studies .
The exemplary performance of many ASEAN economies for a sustained
period has been the basis for a large and varied literature, much of which explores
reasons for the high growth that draws lessons for other countries that would like to
follow suit . A surprising aspect of this literature is the lack of study on the maturation
of the ASEAN miracle . The sustainability of the ASEAN miracle is being questioned
recently as the region's economies are buffeted by problems. The sharp export
slowdown in 1996, financial woes in Indonesia and Thailand, and the very recent
currency turmoil and growth crisis affecting all ASEAN countries raised the question
of the sustainability of the rapid growth in the ASEAN economies .
It is now widely accepted that a stable macroeconomics framework (which
generally means low inflation) is a necessary condition for sustainable economic
growth . Much striking empirical evidence supports the view that a stable
macroeconomics framework is conducive to growth. In Latin America, the
restoration of budget discipline and the reduction of inflation preceded the recovery of
economic growth in Chile and Mexico . On the contrary, the lasting growth crisis in
Brazil was coincides with high inflation punctuated by stabilisation attempts and
4
continued macroecononucs instability (Fischer, S., 1 993). All countries today,
whether they are developed or developing, faced an inflationary pressure. However,
inflation is always a problem that mostly concerned economists and policy makers in
the fast growing developing economies, especially the ASEAN economies, in spite of
the fact that all this while, the region has managed the inflationary pressures quite
well. As a matter of fact, amidst the obvious strains from heated economic
development, the ASEAN countries have been able to maintain single or low double
digit inflation rates in average in the sample period. The worry over inflation is due
primarily to the general view that generating inflation is easier than stopping it and
also, maintaining low inflation is less costly than regaining it once it has surged.
There is, therefore, a good reason and timely to examine the issue of inflation in this
region. Better understanding of the transmission mechanisms of inflation in this region
provides a better understanding of the origin as well as the generation of inflation, and
hence promote a more proactive policy to curb inflation.
The Study of Inflation
Inflation has been the concern of the study because inflation is costly and is
widely viewed as a social disaster, although the degree of its seriousness is debatable .
The effects of inflation are so pervasive that almost everyone is concern about
inflation. When asked about the greatest problem confronting them, most people refer
to inflation and some of them even agree that it has graver consequences than
unemployment and other domestic problems (Katona, 1 983).
5
Virtually, why do we so worry about inflation? The reason why inflation has
been the focus of discussion is that its root cause has not really been tackled so far .
Theoretical and empirical researches on the causes and the processes of inflation
occupied a prominent place in macroeconomics literature . Despite the enormous
growth and diversity of inflation literature, a precise identification of the underlying
causes of inflation remains elusive . This probably due to the fact that inflation appears
to be an empirically observable phenomenon that varies greatly both across countries
and over time. Apart from that, the complexity of the analysis increased as we
venture beyond the domain of closed economies, since there arises a need to specifY
clearly the international transmission of price and other macroeconomics disturbances
that might affect domestic prices .
In the real world, prices do not rise as if lifted by an invisible hand. They are
raised by formal and explicit managerial decision made by a few influential groups of
people . In explaining the nature of inflationary process, demand and cost are always
thought as the roots in transmitting inflation while the growth of money supply is the
main reason for inflation in the longer term. However, the actual causes of inflation
may not be similar everywhere. It may be different under different government
policies, different economic environment or different stages of a nation's economic
and social development . Therefore, any attempt to unravel the causal factors in the
generation and propagation of inflation is bound to open a "paradox's box" of rival
theories .
6
For policy makers, inflation is always a problem that needs to be taken care of.
Yet, government attempts to control inflation have not always been successful. The
failure may be attributed to the wrong diagnosis of the nature of the problem, leading
to the application of inappropriate cures. Essentially, economists have advanced a
variety of diagnoses of the causes of inflation, which have provided the base for
various policy prescriptions. There are basically two schools of thought . First, the
causes of inflation are to be found at the world rather than at the individual economy
level. Henceforth, to handle the problem of inflation, it requires common and
integrated international policies. Second, the causes of inflation should be sought
within the particular structure of each individual economy and each country should
adopt such policies as are appropriate to contain its own special inflationary
pressure8.
Concern about inflation comes forth also due to the fact that inflation,
especially unanticipated inflation is detrimental . To the layperson, inflation means the
shrunk in the value of money used for purchasing goods and services . For the society
as a whole, inflation creates problems in the functioning of the economy. According
to Davis (1991), the effects of inflation can be broadly divided into five general
groups. The first kind of the adverse effect is the so called "menu costs" and "shoe
leather costs" . "Menu costs" are extra costs associated with repricing, including the
costs of printing new menus or distributing new catalogues. The "shoe leather costs"
2 Refer Zis, G. (1993) "Inflation: an international monetalY problem or a national social phenomenon" in Inflation in Open Economies.
7
refer to costs incurred as a result of more frequent move to banks . As a result of
higher inflation and hence higher interest rates, people tend to hold less cash, so they
must go more often to bank to obtain cash by making withdrawals from savings
accounts and other interest-paying assets. The inconvenience and loss of productive
time that people suffer constitute the "shoe leather costs . "
The other inflationary consequences as suggested by Davis included distortion
on the allocation of resources and output, effect on the efficiency of the pricing
system as a signalling device and effect on income distribution from savers (or
creditors) to borrowers (or debtors) as well as effect on social and political stability .
Unanticipated inflation contorts the price signals in the market and introduces noise
into the system with the result that economic agents use up a lot of time and resources
to cope with inflation . Thus a result of inflation is that the rate of growth of the
natural level of output is reduced below what it would be in an inflation-free
economy.
While a move towards equality is often reckoned necessary for the economic
and political stability of many developing countries, especially the fast growing
developing ASEAN countries, inflation worsens the income distribution pattern. At
certain level, inflation puts a strain on the social order as it undercuts the perceived
fairness and predictability of economic outcomes. Many empirical evidences have
shown that inflation was partly responsible for much political unrest in many
countries, especially in the fast growing developing countries . A very recent incident
8
of riots in Indonesia as a result of rising prices is the most concrete example to
support the risk of inflation to the stability of a country.
In view of the damaging effects of inflation on the progress of an economy,
maintaining low inflation has been the primary goal of most countries, especially for
fast growing developing economies. Jarrett and Selody (1982) in a study on inflation
found that a one per cent decline in inflation was associated with a permanent rise in
productivity of 0.38 per cent in Canada. As productivity rises, so does standard of
living, which is the ultimate goal of any economic policy. In addition, low inflation
tends to coexist with low relative price variability and inflation uncertainty (Hess and
Morris, 1996). Caporale and McKiernan (1997) by employing a GARCH model finds
a positive and significant relationship between the level and variability of inflation in
which high inflation leads to more variable inflation. An economy tends to functions
better when aggregate prices, as measured by the CPI for example, are steady rather
than volatile. This is for the reason that price stability allows economic decision
makers, including businesses, investors and consumer to better assess shifts in the
demand and supply for individual goods. This, in tum, encourages a faster and more
optimal allocation of scarce economic resources. On the other hand, price instability
has disruptive effects on economic decisions. It forces businesses and individuals to
spend time and money predicting future prices and hedging against unanticipated
inflation. Because of inflation, economy tends to operate less efficiently. Feldstein
(1983) found that a reduction in inflation of two percentages' points raises the level of
9
GDP by one per cent. As inflation falls, tax distortions stemming from higher inflation
also fall, thus raising savings and hence investment and output.
However, not everyone is thinking that the harm done by inflation is so
significant. Tobin (1972), for instance, has generally perceived that inflation is greatly
exaggerated as a social evil. Several analysts contend that maintaining low inflation is
too costly and the benefits too elusive (Krugman, 1996; Dornbusch and Fischer,
1991). Attempts to reduce the inflation rates, according to these authors, usually
accompany by a reduction in the growth rate of nominal GDP, which is likely to cause
a temporary drop in output and an increase in unemployment. Okun (1974) surveyed
a variety of econometrics evidence and reached the pessimistic conclusion that the
inflation process in the post-war United States is so inertia prone that the cumulative
sacrifice of ten per cent of a year's GNP would be required to achieve a permanent
one per cent point reduction in the inflation rate. Therefore, many economists do not
regard the benefits of lower inflation as worth the sacrifice of lost output and jobs
necessary to achieve it. The very different and contradicted opinions on the effects of
inflation opened up a question for extended investigation.
Statement of Problem
Inflation has been considered as one of the major problem in the management
of macroeconomy. It creates detrimental effects in the functioning of the economy.
Yet, a precise identification of the underlying causes of inflation remains elusive so far