Macroeconomics Problem Learning Objectives: At the end of the chapters, students should be able to understand 1. . !. $. '. ). +. ,. .. 10. 11.

1 . 1!. 1$. 1'. 1). Definition Of Business Cycle Characteristic Of Business Cycle "our #hases Of A Business Cycle Definition Of %ne&ploy&ent %ne&ploy&ent (ate "or&ula *he *ypes Of %ne&ploy&ent *he Causes Of %ne&ploy&ent *he -ffect Of %ne&ploy&ent /ethod *o Control *he %ne&ploy&ent Definition Of 1nflation 1nflation (ate "or&ula Degree Of 1nflation *he *ypes/Causes Of 1nflation *he -ffect Of 1nflation /ethod *o Control *he 1nflation 1nflationary 2ap vs Deflationary 2ap

Introduction *he topic discuss the cause of business cycles so that they can learn ho3 to &oderate or avoid recessions and their har&ful effects on standards of living. *he topic also e4plain on inflation and une&ploy&ent and their effects on individuals, society and the nation. *he fiscal policy, &onetary policy and steps to reduce inflation and une&ploy&ent are also been highlighted. 1. Definition Of Business Cycle A business cycle refers to the regular fluctuation in econo&ic activity in an econo&y as a 3hole.*he ter& business cycle refers to econo&y53ide fluctuations in production or econo&ic activity particularly 3ith regard to national inco&e, e&ploy&ent and output over several &onths or years. 1t is also 6no3n as trade cycle or econo&ic cycle and loo6s li6e a 3ave fluctuate in aggregate output rises for a 3hile, then falls over ti&e. 2. Characteristic Of Business Cycle *he business is never steady. *here are al3ays ups and do3ns in econo&ic activity. 1n business, there are flourishing activities, 3hich ta6e econo&y to prosperity and gro3th 3hereas there are periods 3hen there is recession, 3hich leads to decline in the e&ploy&ent, inco&e and output. 7hen the econo&y goes into do3ns3ing then there is a stage of recovery to reach a ne3 boo&. the &ain characteristics of business cycle are as follo3ing: 1. *he fluctuations are 3ave li6e &ove&ent and are recurrent in nature. . Business Cycle is characteri8ed by 3aves of e4pansion and contraction. !. *here are four phase of business cycle 9 #ea6, (ecession, *rough and (ecovery. $. Business Cycle is self generating. -very phase has ger&s of the ne4t phase, that is, e4pansion has the ger&s of the recession in it.

3. Four Phases Of

Business Cycle

A typical or standard business cycle goes through four different stages or phases. *he four phases of the business cycle are prosperity, recession, depression, and recovery. Both business decisions and consu&er buying patterns differ at each stage of the business cycle. 1. Phase 1! Pros"erity/Boom/Pea# A pea6 is 3hen business activity reaches a te&porary &a4i&u& 3ith full e&ploy&ent and near5capacity output.3here all available resources are e&ployed. *he une&ploy&ent re&ains lo3, strong consu&er confidence about the future leads to record purchases, and businesses e4pand to ta6e advantage of &ar6etplace opportunties. *here are &ore invest&ent co&ing in and increases pressure on available resources. *hus, it leads to the nu&ber of jobs are &ore than the nu&ber of 3or6ers thus lead to increase in prices, 3ages, interest and profit. 2. Phase 2! $ecession/Contraction *he second phase is a recession or called a contraction. 1t is do3n3ards phase in 3hich a business cycle &oves fro& a pea6 to a trough during 3hich output and e&ploy&ent decline.*his phase lasting si4 &onths or &ore 3hen there is an increase in the level of une&ploy&ent :level of e&ployed is lo3est;,a reduction in aggregate inco&e in ter&s of 3age and profit 3hich leads to a decline in consu&ption e4penditure and invest&ent level. Consu&ers fre<uently postpone &ajor purchases and shift buying patterns to3ard basic, functional products carrying lo3 prices. Businesses &irror these changes in the &ar6etplace by slo3ing production, postponing e4pansion plans, reducing inventories, and often cutting the si8e of their 3or6force. 3. Phase 3! De"ression/%rou&h *he third phase is called as trough and e4perience poor econo&ic ti&e. 1t occurs 3hen the overall level of econo&ic activity fall to the lo3est level. %ne&ploy&ent rates during this phase 3ill be higher and 3ill create &any proble&s. *hus, it is a period of great suffering and hardship to society and the 3orst phase of a business cycle. *he trough is the botto& of the recession period. During this ti&e, the econo&ic slo3 do3n continue in a do3n3ard spiral over an e4tended period of ti&e, the econo&y falls into depression. /ost econo&ists believe that society is capable of preventing future depressions through effective econo&ic policies. *hus, it 3ould be follo3ed by an econo&ic recovery '. Phase '! $eco(ery/)*"ansion *he final phase is a recovery stage 3here period of revival leading to an upturn of the econo&y. *he business cycle is having an e4pansion 3here it &oves fro& a trough to a pea6 i.e. 3here output and e&ploy&ent increase *he econo&y=s level of output and e&ploy&ent e4pands to3ards full e&ploy&ent during this phase. 2overn&ent initiate by increasing e4penditure, changes in production techni<ues, ne3 innovations and e4ploitation of ne3 sources of energy. *hus, sti&ulate the de&and for consu&ption and increase de&ands for capital goods. Conse<uently,, the e&ploy&ent level, output, inco&e, 3ages, prices and profits begin to increase. 1n the recovery stage, the econo&y e&erges fro& recession and consu&er spending pic6s up stea&. -ven through business often continue to rely on part ti&e and other te&porary 3or6ers during the early stages of a recovery, une&ploy&ent begins to decline, as business activity accelerates and fir&s see6 additional 3or6ers to &eet gro3ing production de&ands. 2radually, the concerns of recession begin to disappear, and consu&ers start purchasing &ore discretionary ite&s such as vacations and ne3 co&puter e<uip&ent. 1t is i&portant to note that recovery doesn>t necessarily ta6e place at a steady pace.

Business Cycle and Conce"t of Potential +ational Income ,Full )m"loyment- and $eal +ational Income 1. #otential ?ational 1nco&e is total final goods and services that been produced by the country at full e&ploy&ent level. At this stage, all econo&ic resouces are fully utili8ed and having &ini&u& level of une&ploy&ent rate. A country une&ploy&ent rate belo3 or e<ual $@i s regarded has achieve full e&ploy&ent. . (eal ?ational 1nco&e is total final goods and services that been produced by the country 3ithin a year. Level of inco&e is achieved 3hen part or all resources been utili8ed in econo&y. !. According to Aeynes the (eal ?ational 1nco&e -<uilibriu& is achieved 3hen the level of inco&e is higher than, or e<ual ,or belo3 than #otential ?ational 1nco&e. $. Business Cycle cause the (eal ?ational 1nco&e higher than, or e<ual ,or belo3 than #otential ?ational 1nco&e . Pha se 1 .nem"loy ment Lo3est Level 1ncreases Cighest Level Declines 5 5 Inflation Cighest Level Out"ut /a4i&u& Level Declines /ini&u& Level 1ncreases gro3th /tatus (eal DE #otential D (eal D G #otential D (eal D G #otential D (eal D G #otential D (eal D I #otential D Pt A,-,1 B to C " to 2 CH2 C to D 2 to C B,D,", C,J ADEA F ADG AF ADG AF ADG AF ADIA F

#ea6BBoo& (ecession

! $

*rough (ecovery "ull -&ploy&ent

#otential D

recovery (eal 2D# recession

trough trough

Dear

#otential national inco&e curve is a straight line up3ard fro& left to right. 1t sho3s the potential of increasing inco&e levels steady through ti&e. An increase in potential national inco&e due to increase in production factors and i&prove&ent in technology. (eal ?ational 1nco&e is an up3ard and do3n3ard line sho3s a fluctuating econo&y . *he fluctuations in econo&ic activity is referred to as business cycles or econo&ic s3ings. -ach business cycle indicating four stages of econo&ic pheno&enon : inflation, recession,trough and recovery.-cono&y is reaching full e&ploy&ent at point B,D, " C and J 3here (eal D is e<ual to #otential D. "ro& #oint A to B , the contraction occurs but still (eal DE #otential D and there is an e4cess on Aggregate De&and and econo&y start to contract and general price level and inflation decreasing. "ro& #oint B to C , the recession occurs and (eal DG #otential D and there is an e4cess on Aggregate Fupply and econo&y is real poor condition. -cono&ic recession sart to occur and rate of une&ploy&ent 6eep on increasing At point C, the trough ta6es place and e4perience poor econo&ic ti&e. 3hen the overall level of econo&ic activity fall to the lo3est level at point 2 3here econo&ic recession is great.%ne&ploy&ent rates during this phase 3ill be higher and 3ill create &any proble&s. *hus, it is a period of great suffering and hardship to society and the 3orst phase of a business cycle. *he trough is the botto& of the recession period. "ro& #oint C to D , the recovery occurs but still (eal DG #otential D and there is an e4cess on Aggregate Fupply and econo&y is e4panding through govern&ent effort, the econo&y ic begin to recover and reach full e<uilibriu& at point D "ro& #oint D to - , the econo&y is having an e4pansion 3hich total output gro3s rapidly 3here (eal DE #otential D and there is an e4cess on Aggregate De&and and econo&y is begin to have inflation 3here general price level continuously increasing. At point -, the inflation is getting serious and reach the pea6 and output starts to fall. "ro& #oint A till #oint - is a one of business cycle and it 6eep recurring fro& year to year and govern&ent i&ple&ent policy to stabili8e the econo&y.*his roller5coaster pattern is a recurring cycle. Output gro3th is &easured in real 2D# and changes in real 2D# are pro4y for changes in the <uantity of goods and services an econo&y can produce in a year, for e4a&ple, tons of rice, units of cars, nu&ber of houses built, and other goods as 3ell as services.

'. Definition Of .nem"loyment *hose 3ho are in the labour force can also be divided into t3o categories, na&ely those 3ho are e&ployed and those 3ho are not.7e need to defined labour force in order to understand the concept of une&ploy&ent such as full e&ploy&ent,une&ploy&ent,une&ployed,undere&ploy&ent,discouraged 3or6er and labour force 1. Full )m"loyment 4

"ull -&ploy&ent is the situation in 3hich all the 3or6ing labour force are e&ployed to produce goods and services. "ull5e&ploy&ent does not &ean 8ero une&ploy&ent or 100 per cent of the 3or6ing labour force. *he natural rate is achieved 3hen labor &ar6ets are in balanceK the nu&ber of job see6ers e<uals the nu&ber of job vacancies. At this point the econo&y=s potential output is being achieved. 2. .nem"loyment %ne&ploy&ent is defined as labour force participants being available and 3illing to 3or6 but unable to finds jobs. 3. .nem"loyed *he une&ployed are people 3ho are registered as able, available and 3illing to 3or6 at the going 3age rate but 3ho cannot find 3or6 despite an acti(e search for 0or#. %ne&ployed &eans those 3ho are not 3or6ing but are actively loo6ing for jobs. '. .nderem"loyment %ndere&ploy&ent is a ter& used to describe those 3ho ta6e on part5ti&e jobs belo3 their capability but are see6ing full5ti&e e&ploy&ent. #eople 3ith education and s6ills accept uns6illed jobs rather than re&ain une&ployed. "or e4a&ple, a graduate 3or6ing as a salesperson in a super&ar6et. 1. Discoura&ed 2or#er A discouraged 3or6er is an individual 3ho 3ants to 3or6 but has been unsuccessful for a long period of ti&e in finding a job and 3ho has conse<uently given up on see6ing for jobs. Discouraged 3or6ers 3ould li6e to 3or6 if job prospects are good. 3. 4abour force *he labour force is defined as people fro& the total population above 1) years of age, 3ho are not in any institution and 3ho are either e&ployed or une&ployed but actively see6ing e&ploy&ent. Fo, the labour force consists of e&ployed and une&ployed persons. "or those 1) years of age 3ho are not in the labour force are students, house3ives, pensioners, and discouraged 3or6ers. 5. Part!time 0or#ers (s full time 0or#ers #art5ti&e 3or6ers are those 3ho 3or6 less than !' hours a 3ee6. "ull5ti&e 3or6ers are those 3ho 3or6 !' hours or &ore in a 3ee6. 1. .nem"loyment $ate Formula *he rate of une&ploy&ent is an i&portant guide to3ards a country=s econo&ic situation. *he une&ploy&ent rate is defined as the percentage of the labor force that is not e&ployed but actively see6ing e&ploy&ent. .nem"loyment rate ,6- 7 +umber of .nem"loyed 8 1996 4abour Force )*am"le *he schedule belo3 sho3s the total production, labour force and total e&ploy&ent in /alaysia in 00+ and 00,. :ear 2995 :ear 299; %otal Po"ulation ,million+.1 +.+ 4abour Force ,<99910,,,..' 11,0 ,.1 )m"loyed Person ,<99910,'!,.1 10,)'..) +umber of unem"loyed ,<999!'1.$ !),.' 5

Fource: Labour "orce Ftatistics : 00,;, Official 7ebsite of Depart&ent of Ftatistics /alaysia *he une&ploy&ent rate for each year can be calculated as follo3s: %ne&ploy&ent rate for year 00+ I :*otal %ne&ploy&entBlabour force; 4 100 I :!'1.$B10,,,'..; 4 100 I 3.236 %ne&ploy&ent rate for year 00, I :*otal %ne&ployedBlabour force; 4 100 I :!),.'B11,0 ,.1; 4 100 I 3.3'6 *he rate of une&ploy&ent 3ill increase 3hen there is a recession and it 3ill decrease 3hen there is econo&ic gro3th. *he rate of une&ploy&ent 3ill not beco&e 8ero even 3hen there is econo&ic gro3th because there 3ill be so&e une&ploy&ent 3hen there is a change of jobs, or 3hile 3or6ers 3ait for better job opportunities. 3. %he %y"es Of .nem"loyment %ne&ploy&ent ta6es place 3hen people have no jobs and they are 3illing and see6ing for 3or6. *he rate of une&ploy&ent 3ill increase 3hen there is a decline in the econo&y, but une&ploy&ent also happens 3hen the econo&ic situation is good. 1t can be analysed in detail 3hen you understand the different types of une&ploy&ent. Belo3 are the types of une&ploy&ent 1. Frictional .nem"loyment "rictional une&ploy&ent also 6no3n as search une&ploy&ent is a nor&al and transitional une&ploy&ent results fro& bad &atches inthe labour &ar6et. 1t occurs 3hen people are in bet3een jobs , or are entering or reentering the labour force. *his &ay even happen in full e&ploy&ent 3hen people <uit their jobs for a better position or higher 3ages or 3hen fresh graduates are actively see6ing for a job. *his type of une&ploy&ent occurs because of 3or6ers 3ho are voluntarily bet3een jobs. *hese job see6ers &ay be te&porarily une&ployed for a short period of ti&e. 1t happens 3hen individuals are &oving bet3een jobs, careers and locations.Fo&eti&es, people are 3illing to be une&ployed 3hile 3aiting to get another job and not because they are unable to loo6 for a job. 1&perfect infor&ation in the labour &ar6et &ay &a6e frictional une&ploy&ent 3orse if the jobless are una3are of the available jobs. 1ncentives proble&s can also cause so&e frictional une&ploy&ent as so&e people actively loo6ing for a ne3 job &ay opt not to accept paid e&ploy&ent if they believe the ta4 and benefit syste& 3ill reduce the net increase in inco&e fro& ta6ing 3or6. 7hen this happens there are disincentives for the une&ployed to accept 3or6. *his type of une&ploy&ent e4ists because of friction in the labour &ar6et. Jobs &ay e4ists but people do not go to ta6e up jobs a3ay fro& ho&e for do&estic reasons such as children>s education, fa&ily and friendly ties and, housing proble& in a ne3 place. ccordin& to economists this e*ists at all times at a rate of 2!3 "ercent and harms no one. For indi(iduals or &rou"s= it lasts for a fe0 months 0hen "eo"le mo(e from >ob to >ob for better 0a&es or 0ait for better o""ortunities 2. Cyclical .nem"loyment Cyclical %ne&ploy&ent is involuntary une&ploy&ent due to a lac6 of de&and for goods and services. *his is also 6no3n as Aeynesian Lde&and deficientL une&ploy&ent.1t is caused by econo&ic conditions that go up and do3n due to do3ns3ing in a business cycle or a recession *here are fall in aggregate de&and leading to a loss of real national output and e&ploy&ent and a slo3do3n can lead to businesses laying off 3or6ers because they lac6 confidence that de&and 3ill recover. Both e4ternal and internal factors such as 3ars, stri6es, population changes, political disturbances, floods, droughts, changes in consu&ption patterns, invest&ent, savings, spending, supply of credit, business outloo6 etc. bring about this type of une&ploy&ent. *his type of une&ploy&ent 3as a serious proble& before the Fecond 7orld 7ar. ?o3 it has been largely &astered by 2overn&ent activity to control the develop&ent of cycles 3. /tructural/ %echnolo&ical .nem"loyment

Ftructural %ne&ploy&ent e4ists 3hen there is structural changes in the econo&y of a country. *his happen because the co&position of the labour force does not respond <uic6ly to &eet changing de&ands, technological changes or co&petition fro& i&ported goods and so on. *he 3or6ers find that their s6ills, talents and e4perience are obsolete and un3anted due to changes in technology and consu&er de&and A 3or6er loses a job because that job is no longer a part of the structure of the econo&y. 7hen they don=t have the right s6ills and <ualifications for today=s 3or6 and the needs of businesses.e.g . co&puter s6ills, co&&unication and etc. 1t is caused by a change in the de&and for the products of a given industry. *he closing of the particular industry &ay cause structural changes in the nation>s industry as a 3hole. 1f labour is specific, it is i&&obile bet3een industries and une&ploy&ent results. *he pace of &odern technology is so fast that it &a6es past techni<ues obsolete, causing une&ploy&ent in old industries.*echnological %ne&ploy&ent is a type of une&ploy&ent 3hich is caused by changes in the techni<ues of production. *echnological changes are ta6ing place constantly and there is a need for the labour force to 6eep the&selves updated and be responsive to this changes."or e4a&ple, in the agricultural sector, &any uns6illed and inade<uately educated 3or6ers are laid off because of &odern &echani8ation. '. Casual and /easonal .nem"loyment Casual and Feasonal %ne&ploy&ent is a 6ind of regular seasonal changes in e&ploy&ent B labour de&and. 1t arises due to a seasonal variation in the activities of particular industries. *his &ay be caused by cli&atic changes or changes in fashion or by the inherent nature of the industries the&selves . 1n this type of e&ploy&ent, the labour force is e&ployed at ti&es and une&ployed at other ti&es. 1t affects certain industries &ore than others li6e catering and leisure, construction, retailing, touris& and agriculture. One e4a&ple is a fisher&an 3ho is unable to catch fish in 3inter or in rainy 3eather. Fo&e occupations are adversely affected by 3eather conditions and 3or6ers in these trades e4pect a certain a&ount of casual une&ploy&ent. Feasonal une&ploy&ent often occurs in agriculture, doc6yard, hotels, restaurants and construction business. Fuch une&ploy&ent is inevitable and tends to be overco&e by casual labour 1. Dis&uised/?idden .nem"loyment DisguisedBCidden %ne&ploy&ent is a type of une&ploy&ent to be found in the bac63ard and the underdeveloped countries of Asia and Africa. 1t refers to the &ass une&ploy&ent and undere&ploy&ent 3hich prevail in the agricultural sector of an underdeveloped and overpopulated country. 3. $esidual .nem"loyment (esidual %ne&ploy&ent is a type of une&ploy&ent is caused by personal factors such as old age, physical or &ental disability, poor 3or6 attitudes and inade<uate training. 5. $eal 2a&e .nem"loyment (eal 7age %ne&ploy&ent is considered to be the result of real 3ages being above their &ar6et clearing level leading to an e4cess supply of labour. Fo&e econo&ists believe that the &ini&u& 3age ris6s creating une&ploy&ent in industries 3here international co&petition fro& lo35labour cost producers is severe. As yet, there is relatively little evidence that the &ini&u& 3age has created rising une&ploy&ent on the scale that 3as feared. 1t created 3hen real 3ages are &aintained above their &ar6et clearing level leading to an e4cess supply of labour at the prevailing 3age rate. Fo&e econo&ists believe that une&ploy&ent can be created if the national &ini&u& 3age is set too high. 5. %he Causes Of .nem"loyment *he &ain causes of une&ploy&ent are obvious 3hen you have no jobs and cannot find the job. 1n todays &odern econo&y &any factors contribute to une&ploy&ent. %ne&ploy&ent causes are varied and due to the follo3ing factors 1. 4ac# of e*"erience ?o3adays, the e&ployer 3ill find the 3or6er 3ho had a lot of e4perienced one co&pared to the one 3ithout e4perience. Lac6 of e4perience and s6ills are also causes of graduate une&ploy&ent. 2enerally, &ost organi8ations prefer to e&ploy graduates 3ith e4perience. 2. 4ac# of social and communication s#ill

/any e&ployers cited lac6 of necessary co&&unication s6ills, poor co&&and of -nglish and lac6 of confidence during intervie3s had led to increasing nu&ber of une&ployed graduates. 3. 2ron& course and the "oor result 1n a /alay /ail article, it 3as highlighted that a substantial portion of the registered )),000 une&ployed graduates are fro& so&e of the &ost popular courses. Business ad&inistration, co&puter and infor&ation technology, and engineering are the &ost sought5after courses by &any school leavers. *his has resulted in a high nu&ber of une&ploy&ent a&ong graduates fro& these disciplines *he botto&line is, students should pic6 courses based on their capabilities and not based on 3hat>s apparently Lin5de&andL out there :e.g., 1* courses;. '. Defecti(e education *he day5to5day education is very defective and is confir&ed 3ithin the class roo& only. 1ts &ain ai& is to ac<uire certificated only. *he present educational syste& is not job oriented, it is degree oriented. 1t is defective on the ground that is &ore general then the vocational. *hus, the people 3ho have getting general education are unable to do any 3or6. *hey are to be called as good for nothing in the ground that they cannot have any job suits the&. 1. @ob losers A job loser is so&eone 3ho has been involuntarily ter&inated or laid off fro& a job, 3hether te&porarily or per&anently. *here are &any reasons for this, e4a&ple, failure of the 3or6er to fulfil his 3or6 re<uire&entsBconditions or the fir&>s failure to fulfill its e&ployee>s needs. *hose 3ho have lost their jobs have t3o choices either to loo6 for a ne3 job or leave the labour force. *hose 3ho leave the labour force are not considered une&ployed. 3. @ob lea(ers here are so&e 3ho voluntarily leave their jobs and not necessarily because they 3ere laid off. 1f they 3ere leaving one job because they 3ere accepting another offer, then this 3ould not contribute to3ards the increase in une&ploy&ent rate. *he une&ploy&ent rate 3ill only increase if these job leavers 3ere still loo6ing for a ne3 job. 5. +e0 entrants and re!entrants ?e3 entrants are those 3ho have just co&pleted their studies and are ready to join the 3or6 force. *hey have never before been e&ployed and are actively see6ing e&ploy&ent for the first ti&e. Co3ever, 3hile loo6ing for a suitable job, they have to be une&ployed

;. %he )ffect Of .nem"loyment %ne&ploy&ent is a co&&on pheno&enon. Co3ever, a high une&ploy&ent rate 3ill affect a country=s econo&ic gro3th. *he negative effect on une&ploy&ent can be brea6do3n to the negative effect on econo&y, individual, society and govern&ent,. 1. %he +e&ati(e )ffect On )conomy A high rate of une&ploy&ent 3ill give a big i&pact a country=s econo&ic activity. *he follo3ing sho3s the negative effects of une&ploy&ent on the econo&y. 1. $uin the economic &ro0th 8

Cigh une&ploy&ent rate 3ill ruin the econo&ic gro3th and perfor&ance. *here 3ill also be e4cess capacity fro& the industrial &achines. *his 3ill indirectly cause a drop in invest&ent level. Ferious proble& of une&ploy&ent in the econo&y are not conducive for invest&ent because fir&s still have e4cess production capacity and there are capital goods and e<uip&ent that the fir& have abandoned or not fully utili8ed during the recession. *herefore, ne3 invest&ent is needed to increase output. lo3 level of aggregate spending in an econo&ic recession reduces the i&pact of the desire of investors to &a6e invest&ents. lac6 of invest&ent in the econo&y is to reduce econo&ic gro3th. Flo3 econo&ic gro3th and lo3 output 3ill lead to further depression. *he high rate of une&ploy&ent and sluggish activities of fir&s 3ill result in a reduction in their profits. *he lo3 profits 3ill reduce the eagerness of investors to &a6e ne3 invest&ents. *his 3ill affect national econo&ic gro3th 2. 2asta&e of "roduction resources Cigh rate of une&ploy&ent forces the econo&y to operate at a level belo3 &a4i&u&. *he 3astage of resources bring about output production far lo3er than the potential output. %ne&ploy&ent &eans that labor is not utili8ed and other factors of production that is the fi4ed capital such as plant and soil factors such as agricultural land is 3asted. *his situation 3ill reduce real 2?#, thus leading to real 2?# G potential 2D# Cigh rate of une&ploy&ent forces econo&y to operate at a level belo3 &a4i&u&. %ne&ploy&ent seen as an inefficient 3ay of allocating resources 9 labour &ar6et failureM *he result is that fir&s e4perience inefficiency in production. Li&it the possibility of production is not achieved in the econo&y. *his situation also lo3ers the current production capacity and thus prevent future econo&ic gro3th 3. Fall in +ational "er ca"ita income %ne&ploy&ent causes national inco&e that is achieved is lo3er than the potential of national inco&e. %ne&ploy&ent resulted in a lo3er state ta4 collections. *his &eans that the achieved level of social 3elfare is lo3er than the level that &ay be achieved. %ne&ploy&ent causes national inco&e is achieved is lo3er than the potential of national inco&e. %ne&ploy&ent resulted in a lo3er state ta4 collections. *his &eans that the achieved level of social 3elfare is lo3er than the level that &ay be achieved. %ne&ploy&ent causes national inco&e is achieved is lo3er than the potential of national inco&e. %ne&ploy&ent resulted in a lo3er state ta4 collections. *his &eans that the achieved level of social 3elfare is lo3er than the level that &ay be achieved '. +ot achie(e full em"loyment *his is because there is no labor utili8ed to lead the country does not achieve econo&ies of scale of production at the potential level that can be achieved . *his situation is said to be not reached a level of full e&ploy&ent. *his &eans that the country has lost output and resulted in gro3th of 2ross ?ational #roduct :2?#; is lo3. Lo3 2?# 3ill affect the country>s per capita inco&e, a &easure of standard of living. 1n general if a country>s une&ploy&ent rate is 3ithin @ to $@, the country is dee&ed to have reached full e&ploy&ent. %ne&ploy&ent also 3ill 3iden the inco&e gap bet3een rich and poor to the end 3ill lead to a &ore co&ple4 social proble&s.

2. %he +e&ati(e )ffect On Indi(idual Fo&e of the negative effects of une&ploy&ent on the individual are: 1. 4oss of li(elihood and income %ne&ploy&ent causes loss of inco&e of individuals. "or countries 3ith no une&ploy&ent insurance progra&, individuals &ust rely on past savings or borro3 fro& relatives and friends to survive 3ill affect their life because they are unable to have a stable inco&e.. Cause hardship, aggravate tensions in fa&ily relationships and fa&ily and create various types of fa&ily proble&s li6e divorce and argu&ents. 2. 4oss of >ob s#ills

Fo&e s6ills can only be &aintained if they are used or practiced often. Long5ter& une&ploy&ent &ight cause an individual to lose hisBher s6ills. Labor force have been une&ployed 3ill lose s6ills in perfor&ing a job. F6ills in perfor&ing a job can only be &aintain 3hen the s6ills to use regularly. F6ills in certain jobs can only be &aintained if they are put into practice.%ne&ploy&ent that occurs 3ill cause anyone 3ho has a s6ill that decline. %ne&ploy&ent can lead to social and political proble&s. Fo&e s6ills can only be &aintained if they are used or practiced often. Long5ter& une&ploy&ent &ight cause an individual to lose hisBher s6ills. %&e&ployed 3or6er &ay lose their job s6ills through a lac6 of application.retraining and educating the& &ay prove e4pensive .%ne&ployed laborers 3ho have been long une&ployed 3ill lose their s6ills and e&ployers are forced to retrain 3or6ers. *his 3ill involve a high cost for the training 3hich resulted in the loss of high co&petitiveness at international level. As a result, local products can not co&pete 3ith the cheaper foreign goods and <uality of the products.*hus, long5ter& une&ploy&ent 3ill cause the s6ills of an individual to deteriorate. 3. 4oss of confidence %ne&ploy&ent has i&portant social costs eg une<ual inco&e and di&inished social cohesionK loss of status, alienation and frustration. %ne&ploy&ent also cause loss of self confidence and 3ill lead to depression. Atte&pts to get a job that has al3ays failed to erode the confidence of the labor force. %ne&ployed people &ay also e4perience depression because of the 6no3ledge and s6ills ac<uired fro& education institutions can not be used to &a6e a living to support the&selves and their fa&ilies. 3. %he +e&ati(e )ffect On /ociety Fo&e of the negative effects of une&ploy&ent on the society are: 1. Family dis"ute %ne&ploy&ent 3ill &a6e households 3ill lose inco&e to support fa&ily life. As a result, fa&ily relationships are affected and in turn destroy the fa&ily function in a country. Children 3ill be left 3ithout the proper education and proper health facilities 3ithout. 1n the long run it 3ill cause proble&s of poverty 3ill continue to be inherited to ne4t generation . Domestic (iolence *e&porary une&ploy&ent 3ill not ruin the lives of the people as daily activities can be carried out using savings or loans. Co3ever, continuous une&ploy&ent 3ill create unhealthy side effects such as being forced to parta6e in illegal activities to obtain &oney. Loss of inco&e and e4penditure re<uire&ents 3ill lead to financial proble&s in the fa&ily une&ployed. %ne&ploy&ent increase the nu&ber of poor fa&ilies in the co&&unity. *herefore, the increase in the nu&ber of une&ployed 3ill threaten social peace. Other social proble&s are theft and robbery !. 4o0 standard of li(in&

%ne&ploy&ent &eans 3astage factor of production and the econo&y is not achieving the &a4i&u& production capacity. (eal national inco&e is less than the inco&e potential of the country. Ftandard of living lo3er than the level that &ay be achieved if the econo&y has achieved e&ploy&ent as the a&ount and type of goods enjoyed by the population is less than if full e&ploy&ent is reached. '. %he +e&ati(e )ffect On Ao(ernment A high rate of une&ploy&ent 3ill be hard fro& govern&ent side. Belo3 are the negative effects of une&ploy&ent to the govern&ent. i. %hreat to "olitical stability

Long5ter& or continuous une&ploy&ent can create chaos and the govern&ent 3ill be under pressure and receive criticis&s fro& &any parties. *his proble& indirectly contributes to3ards social proble&s and causes an increase in cri&e rates. 1ncrease in cri&e rates can cause foreign investors to shy a3ay

10

Fluggish econo&ic activity and high une&ploy&ent rate &ay rise to grievances against the ad&inistration of society. 2overn&ent inability to address effectively the proble& of une&ploy&ent 3ill rise to feelings of dissatisfaction and anger of the people. *his under&ines social and political stability, 3hen criticis& and clai&s 3ill be sub&itted to the govern&ent if the people held de&onstrations and stri6es and chaos. ii. Increase criminal rate As a result of fa&ily instability and poverty, people 3ill do 3hatever activities including econo&ic activities are illegal, fraud, s&uggling, blac6 &ar6ets, theft, prostitution and so forth. Fuch activities are difficult to contain by the govern&ent and at the sa&e ti&e the govern&ent had to provide large e4penditures for enforcing the rules, 3hile provision is better used for develop&ent of a &ore 3orth3hile. Card ti&es also force the une&ployed to do so&e cri&inal activities such as robbery and theft that threatens the social order. 1n so&e e4tre&e cases, une&ployed 3or6ers &ay join radical groups and engage in troubleso&e social and political activities. *he cri&e rate 3ould be high if une&ploy&ent is high. iii. Dro" in &o(ernment re(enue %ne&ploy&ent causes losses in govern&ent revenue obtained through personal ta4es because &any have joined the ran6s of the une&ployed decrease national inco&eBgovern&ent revenue obtained fro& personal ta4es. 7hen people are une&ployed, the ta4 collection is also reduced. i(. /Buatters "roblem 7hen inco&e is lost, no longer able to get a good basic facilities. *hey had to find a cheaper ho&e to create &ore s<uatter settle&ents. F<uatter proble& does not end here because the lac6 of basic a&enities to create the proble& of hygiene and health to the nation. 1ndirectly, the country 3ill lose attraction. (. /ocial and "olitical "roblems Flo3 econo&ic activities and the high rate of une&ploy&ent 3ill cause dissatisfaction a&ong the population to3ards the govern&ent. Criticis&s and de&ands 3ill be &ade to the govern&ent and de&onstrations &ay occur, apart fro& other social proble&s such as theft and robbery. (i. Decline of &o(ernment de(elo"ment acti(ities %ne&ploy&ent 3ill cause the decrease in the govern&ent revenue through the collection of personal inco&e ta4 because so&e citi8ens do not have e&ploy&ent nor inco&e. *his 3ill reduce the govern&ent>s ability to proceed 3ith national econo&ic develop&ent activities since the total revenue received by the govern&ent is reduced.

C. Method %o Control %he .nem"loyment Monetary/Financial Policy %o Combat .nem"loyment /onetary policies 3hich consist of controlling the supply of &oney by the central ban6 are enforced by using the different &onetary instru&ents 3hich ai& at reducing the supply of &oney. By applying e4pansionary Nuantitative and Nualitative /onetary #olicy 3ill increase &oney supply and hence increase Aggregate De&and to sti&ulate econo&ic gro3th and to control econo&ic recession. Duantitati(e )*"ansionary Monetary Policy 11

*here are various instru&ents or tools of &onetary policies 3hich the central ban6 e&ploys to achieve the goals of the econo&ic policy that is to co&bat une&ploy&ent as follo3ing: 1. $educe minimum reBuirement of statutory cash reser(e ratio and 2. liBuidity asset During recession, the Central Ban6 3ill reduce the rate of statutory reserve . (educing the reserve re<uire&ents decreases the a&ount of re<uired reserves the ban6 &ust 6eep 3here the need for savings of financial institutions in the central ban6 3ill decrease. "ollo3ing this, the li<uidity state of financial institutions 3ill increase as this 3ould increase the ability of ban6 or other financial inter&ediary to provide loans to the public and this has the effect of increasing the &oney supply in the econo&y. Besides cash reserves, co&&ercial ban6s also have to 6eep li<uidated assets issued by Ban6 ?egara /alaysia :B?/; such as treasury bills and govern&ent securities. *he less re<uired li<uidated assets that are held, the &ore the credit that can be created. *he re<uired &ini&u& li<uidated assets are fi4ed by Ban6 ?egara /alaysia and are used as a &onetary policy tool to control the /alaysian econo&ic stability 3. Buy &o(ernment securities in o"en mar#et o"eration Open 9&ar6et operation is the buying and selling of govern&ent securities in the open &ar6ets by the central ban6 so as to influence the si8e of co&&ercial ban6s= deposits. 1n ti&e of deflation, the supply of &oney has to be pu&p in the econo&y. *he central ban6 3ill buy govern&ent securities fro& the co&&ercial ban6s and individuals. #ay&ent &ade 3ill increase cash reserves of co&&ercial ban6s and thus co&&ercial ban6s can create &ore credit, thus, there 3ill be &ore &oney spend by public in the econo&y. *he &oney fro& the sale can be used by govern&ent to sustain its e4penses 3hen its e4penditure e4ceeds the revenue fro& ta4es collected :2 E*;. '. Decrease ban# rate and discount rate o"eration During recession, the ban6 rate 3ill be reduced as &ore &oney need to be pu&p into the econo&y. 7ith lo3er ban6 rate the cost of borro3ing is lo3er, thus &ore 3ill borro3 and &ore loans 3ill be approved. Conse<uently, the flo3 of &oney fro& the co&&ercial ban6s to the public gets increased. 7hen there is a recession, the central ban6 can also decrease discount rate. 1f the ratios of discount rate are reduced, the need for savings of financial institutions in the central ban6 3ill fall. "ollo3ing this, the li<uidity state of financial institutions 3ill increase and this 3ill cause the financial institutions to provide &ore loans to the public.

1. $educe Interest $ate During recession, the govern&ent can reduce the interest rate. *his is to encourage &ore &oney to be spent by consu&ption e4penditure of households. *he Central Ban6 &ay persuade co&&ercial ban6 to decrease their rate of interest on deposit fro& the public. *his action fro& co&&ercial ban6 3ill reduce the level of savings and increase the purchase of goods and services by public. "or e4a&ple, an reduction of the interest rate on fi4ed deposits fro&10 @ to ) @3ill result in consu&er saving less and spending &ore .Consu&ers loo6 at interest rates as costs of loans. *he lo3er the interest rate is, the higher the 3ish of consu&ers to borro3. *he sa&e applies to loan re5pay&ent periods. *he longer the re5pay&ent period, the consu&ers 3ould li6e to &a6e loans because they can afford to pay a lo3er &onthly install&ent. 1nterest rate can be used to influence the cost of borro3ing for consu&ption. A lo3 interest rates &ight be seen as a re<uire&ent for sti&ulating consu&er spending, so as to 6eep econo&y e4pansion. 7hen &oney supply increases, the interest rate 3ill decrease. *his 3ill cause the 12

savings to decrease but encourage invest&ent and consu&ption. A &onetary policy in 3hich a central ban6 sets lo3 interest so that credit is easily attainable. *his &a6e borro3ing easy for business, 3hich sti&ulate invest&ent and e4pansion of operations. Dualitati(e )*"ansionary Monetary Policy %o Combat .nem"loyment -4pansionary <ualitative &onetary policy 3ill encourage ban6 lending in order to sti&ulate econo&ic gro3th and to co&bat econo&ic recession but tightening the loan during inflation. *his can be done through selective credit control to deter&ines the type of loan 3hich should be de&oted or pro&oted and &oral persuasion 3here central ban6 has direct &eeting 3ith representatives of co&&ercial ban6s to e4plain the condition of econo&ic and financial state of the country and give so&e reco&&endation. . /electi(e Credit Controls Felective credit controls Felective credit controls regulate the e4tension of credit for particular purpose. *ightening selective credit controls 3ill li&it certain types of spending and rela4ation 3ill increase spending. *he &ain purpose of perfor&ing selective credit control is to ensure that co&&ercial ban6s provide loans and &a6e invest&ents in accordance 3ith govern&ent aspiration. 1t is not intended to control the total a&ount of &oney created by co&&ercial ban6s through their lending and invest&ent activities but rather on the pattern of loan and invest&ent &ade by co&&ercial ban6s. *he Central Ban6 controls the granting of credits 3hich financial institutions give to the public or investors.1n the case of deflation or recession or une&ploy&ent, rela4ation and loosing the selective credit control 3ill increase spending and encouraging activities in econo&ic sectors. i. $educe control on mar&in reBuirement

Ban6s or other financial institutions routinely lend &oney to custo&ers to buy securities. *he L&arginL is the portion of a security that the regulated institution>s loan is not allo3ed to cover. 1n other 3ords, if a ban6 3ere allo3ed to loan up to O,0 to a custo&er eager to buy O100 of stoc6, the &argin 3ould be O 0. By increasing or decreasing the &argin re<uire&ent, the authorities can effectively tighten the &oney supply.Control of &argin re<uire&ents li&it the volu&e of loans for purchase of shares. -4a&ple: 1f the &argin re<uire&ent is !0@, this &eans that individuals have to pay !0@ of the share price and the re&aining +0@ can be financed through ban6 loans. *herefore, deter&ination of the lo3er &argin re<uire&ents 3ill increase the ability of people to buy shares through a loan. ii. $educe control on credit mort&a&e

Control on credit &ortgage is control the loan on buying property through &ortgage. During recession, the Central Ban6 i&poses a loose &ortgage conditions to encourage the public to buy the property and thus encourage &ortgage credit creation process. iii. $educe control on credit installment Control of activities on credit install&ent affecting purchasing goods trough loan or install&ent. During recession, credit install&ent ter&s loosely as a &ini&u& reduction of advance pay&ents and the e4tension of repay&ent period 3ill pro&ote the activities of credit purchases. i(. /"ecial directi(e

*he central ban6 3ill instruct co&&ercial ban6s to increase the volu&e of loans given to the public. *he central ban6 3ill also influence co&&ercial ban6s to loosen their lending policy such as the need for collateral security, guarantors and other &easures, 3hich 3ill encourage borro3ings. *he central ban6 &ay issue special instructions
as6ed co&&ercial ban6s to allocate a portion of its reserve funds to lend to certain sectors such as agriculture sector involved in food production and s&all and &ediu& enterprises

B. Moral Persuasion *his policy is carried out by the central ban6 not to set in 3riting the things that should be done by co&&ercial ban6s, but 3ith a direct &eeting 3ith the ban6s. 1n this &eeting the central ban6 outlines the steps the govern&ent 13

and the ongoing assistance that desired by the central ban6 fro& co&&ercial ban6s to ensure the success of these actions. "ro& this &eeting the co&&ercial ban6s 3ill find the steps to the efforts being ta6en by the govern&ent 3ill achieve the purpose and e4pected i&pact. *his is done by central ban6 3hen &eeting 3ith representatives of co&&ercial ban6s. 1n the &eeting, central ban6 3ill e4plain the econo&ic and financial state of the country and as6 the co&&ercial ban6s to ta6e certain steps to overco&e any financial and econo&ic proble&s faced. "or e4a&ple, during econo&ic do3nturn, co&&ercial ban6s 3ill ta6e into account the borro3er>s financial state before forcing hi& to re5pay his loan. *he central ban6 can also give advice to co&&ercial ban6s to conduct ban6ing activities in line 3ith govern&ent re<uire&ents to ensure the success of particular policies.During recession, co&&ercial ban6s are encouraged to increase lending to certain econo&ic sectors to assist the govern&ent in an effort to develop the sector. Fiscal Policy to combat .nem"loyment 1n recession, the econo&y suffers fro& rising une&ploy&ent, falling inco&e and shrin6ing econo&y activity. *he govern&ent can i&ple&ent an e4pansionary fiscal policy by increasing govern&ent e4penditure and reducing the ta4 rate. *hese &easures 3ill encourage econo&ic gro3th by creating &ore e&ploy&ent opportunities such as the i&ple&entation of &ajor develop&ent projects, thus having &ultiplier effects on s&all industries. )*"ansionary Fiscal Policy or Deficit Bud&et Policy *his policy is i&ple&ented to get the econo&y out of a slu&p. *his &easure 3ill increase the disposable inco&e 3hich 3ill, in turn, lead to an increase in consu&ption. 1. Increasin& Ao(ernment )*"enditure *hrough e4pansionary fiscal policy, that is by increasing govern&ent e4penditure, e.g. increasing e4penditure to retain those being retrenched. *he govern&ent 3ill increase public spending by underta6ing public 3or6s progra&&es . 2. Increasin& %ransfer Payment 1ncreasing transfer pay&ent, for e4a&ple, increasing pay&ent to those affected by recession is another strategy as they 3ill no3 have &ore &oney in their poc6et thus increasing their spending 3hich 3ill eventually increase aggregate de&and in the econo&y. Fi&ilarly, govern&ent can help those being retrenched by giving une&ploy&ent benefits 3. Decreasin& %a* *a4 cuts are essential to spurring econo&ic activities, by putting &oney in people=s hand they can start spending again, thereby increasing aggregate de&and and restoring full e&ploy&ent .*he effect of ta4 cuts 3ould increase the a&ount of disposable inco&e of individual and business fir&s.

Direct Control Measures/Policy to combat .nem"loyment

Measures %o O(ercome Frictional .nem"loyment 1. Disseminate 4abor Mar#et Information

14

1&perfections in the labor &ar6et lead to frictional une&ploy&ent e4ists in 3hich une&ploy&ent is not a3are of e4isting jobs in the econo&y. 1nfor&ation about e&ploy&ent opportunities &ay be disse&inated through various channels such as &ass &edia and the internet. -ducational institutions can also conduct counseling and career tal6s for students to e4pand their 6no3ledge of career fields that can be pursued based on their interests and abilities 2. Increase 4abor Mobility Labor &obility and e&ploy&ent &obility is divided into geographical &obility. Occupational &obility of labor refers to the ability to &ove fro& one job to another job. 2eographical &obility of labor refers to the ability to &ove fro& one place to another. 1ndividuals 3ith lo3 job &obility difficult to find e&ploy&ent because they had no other s6ills needed to s3itch to another place of e&ploy&ent 3here e&ploy&ent opportunities e4ist. *hus, labor &obility should be i&proved through training to e<uip 3or6ers 3ith other s6ills and enable the& to adjust the&selves in accordance 3ith the re<uire&ents of the labor &ar6et. *he govern&ent could also encourage the develop&ent of the &anufacturing sector in the rural areas to overco&e the proble& of une&ploy&ent in rural areas 3. Creation of +e0 )m"loyment O""ortunities ?e3 e&ploy&ent opportunities should be created to absorb ne3 labor force entry. *hrough the ./#, the govern&ent ai&s to increase the value5added sectors of the econo&y and create a 6no3ledge5based econo&ic activities. Fuch a &ove ai&ed at creating e&ploy&ent opportunities in the field of infor&ation and co&&unication technology :1C*;, biotechnology, nanotechnology and services. ?ational Biotechnology #olicy :?B#;, spanning the period of 1' years fro& 00' to 0 0 is e4pected to attract the establish&ent of ne3 co&panies and create jobs for the population. *he planned opening of ne3 land develop&ent projects A-JO(A region :Johor;, A-*-?2AC :*erengganu;, and A-F-DA( :Aelantan; has been providing job opportunities especially in rural '. )ncoura&in& Forei&n In(estment "oreign 1nvest&ent in various econo&ic sectors 3ill sti&ulate econo&ic activity and create jobs for residents and reduce une&ploy&ent proble& in the country. *o attract foreign investors, the govern&ent has provided various types of infrastructure such as transport and electricity and sufficient 3ater to reduce the cost of doing business to foreign investors. Parious incentives have been offered to foreign investors such as pioneer status, invest&ent ta4 allo3ance and re5establish&ent of free co&&ercial ter&s to increase the co&petitiveness of the country to attract foreign invest&ent

Measures %o O(ercome /tructural and %echnolo&ical .nem"loyment

1. ."&rade s#ill and technical education and $etrainin& /any of the ne3 labor force entering the labor &ar6et are une&ployed due to lac6 of re<uired s6ills. *he establish&ent of s6ills such as 1ndustrial *raining 1nstitute, Advanced *echnology *raining Center :C15 *ech; and Japanese5/alaysia *echnical institute also provides training to school leavers 3ith the s6ills needed by industry. 2raduate *raining Fche&e by the govern&ent ai&s to provide graduates 3ith specific s6ills to reduce une&ploy&ent a&ong graduates. /ore training and education are provided to the une&ployed. this could help i&prove co&puter s6ills and co&&unication. these people 3ill beco&e &ore confident and e&ployable. 2. Increased in(estment in 0or#er trainin&: *he &ain shortages are in highly s6illed jobs and in areas 3here living costs are 3ell above the national average. the govern&ent has suffered fro& a shortage of 3or6ers in 6ey public sector jobs. *raining and education should be given to individuals 3ho have difficulties gaining e&ploy&ent. s6ills obtained fro& the training 3ill help the& to hold suitable posts. &ore training and technical education should be provided for individuals 3ho have difficulties securing a job. 3hen people upgrade their s6ills and increase their 6no3ledge, they 3ill be able to find job easily. 1. Creation of more em"loyment o""ortunities in (arious economic sectors

15

All econo&ic sectors should be developed to support &ore &anpo3er and thus reduce the rate of une&ploy&ent. 7hen econo&ic sectors such as transport, finance, insurance, property and services e4pand, this 3ill result in &ore job opportunities for the public

Measures %o O(ercome Casual and /easonal .nem"loyment

1. Di(ersify economic acti(ity Feasonal une&ploy&ent can be reduced if the une&ployed in the pri&ary sector to diversify their econo&ic activities to earn inco&e fro& other sources 3hen the econo&y failed to resu&e daily activities. "or e4a&ple, fisher&en 3ho are unable to sea during the &onsoon season &ay be involved in s&all businesses such as crac6er production or sale of ca6es. 2overn&ent can provide financial assistance through govern&ent agencies specific to the parties concerned. 2. De(elo"ment of ne0 land *he opening of ne3 land for the suburban sector 3ill also create job opportunities for the people, especially those in the suburban areas. 1t 3ill enable the& to involve the&selves in the agricultural and ani&al husbandry sector and thus obtain an inco&e. 1t 3ill also reduce the &igration of the people fro& the suburban areas to to3ns in search of job opportunities. *he develop&ent of ne3 land is trough govern&ent agencies such as "-LDA,(1FDA and "-LC(A.

Measures %o O(ercome Dis&uised/?idden .nem"loyment

1. Family "lannin& in lon& run Cidden une&ploy&ent occurs 3hen there is an e4cess nu&ber of labor force co&pared to the total land area in countries that have a larger population. By ta6ing long ter& &easure, each household is encouraged to adopt fa&ily planning by birth control in order to slo3 do3n an increase in the supply of labour. 2. ModerniEation of a&riculture sector /oderni8ation of the agriculture sector should be enhanced by the govern&ent so that surplus labor is reduced B eli&inated. 3. Im"ro(e le(el of education *he govern&ent should also i&prove the education of the peasant that they changed the attitude of the active in traditional agriculture to &odern agriculture B far&ing.

Measures %o O(ercome $eal 2a&e .nem"loyment

1. $estrict 4abor .nion cti(ity *rade unions 3ith &any &e&bers 3ho have strong bargaining po3er to de&and higher 3ages. %nions could push e&ployers to set a &ini&u& 3age or higher 3age than the &ar6et 3age rate. 7age increases raise the cost of producing output. *his causes producers to transfer their &anufacturing operations to other countries that have cost relatively lo3er. *his situation reduces the e&ploy&ent opportunities in the country and 3orsen the une&ploy&ent proble&. *herefore, the govern&ent should curb the activities of trade unions to ensure that the labor 3age rate is co&petitive co&pared to other countries and not the arbitrary union de&anded 3age increases 3ithout raising their productivity.

19. Definition Of Inflation 16

1nflation is also a situation 3here there is Qtoo &uch &oney chasing too fe3 goods=.Occurs 3hen there is an continuous increase in the general level of price. 1t reduces a person=s inco&e by reducing the purchasing po3er of &oney. Fince inflation refers to a continuous increase in the general price level although the price of every product and service need not increase. -g: if the inflation rate is $@, it does not &ean that all prices are increasing by $@. 1t is only the average increase. *here are the three &ain criteria to deter&ine inflation are: 1. 1nflation is the increase in general price level &eans that all the goods and services in the econo&y e4perienced a rise in prices. . 1nflation is a continuous increase in price level &eans that the general price level is rising continuously for the long ter& !. 1nflation is the unli&ited increase in price level &eans that the increase in the general price level is very high. 1n short, the rising level of prices in an econo&y that does not include the three criteria is not 6no3n as inflation. 1nflation can also be referred to as a condition in 3hich too &uch &oney purchasing too fe3 goods and services. 11. Inflation $ate Formula *he consu&er price inde4 is used to &easure the rate of inflation. *he consu&er price inde4 :C#1; is an inde4 that &easures changes in the average price of consu&er goods and services. *he C#1 is also called the cost of living inde4. *he co&putation of the C#1 3ill be discussed in the ne4t chapter 3hich deals 3ith si&ple and 3eighted price inde4. *he rate of inflation is co&puted as a percentage change in the C#1 fro& one year to the ne4t. Inflation rate 7 CPI this year! CPI "re(ious year/CPI "re(ious yearF199 *he for&ula belo3 sho3s ho3 the rate of inflation is co&puted. "or e4a&ple, given that the C#1 for the year 000 3as 1 1 and that for the year 001,110, the inflation rate using the above for&ula 3ould be Inflation rate 7 121!119/119F199 7196 *he consu&er price inde4 is used to &easure the rate of inflation. *he consu&er price inde4 :C"1; is an inde4 that &easures changes in the average price of consu&er goods and services. *he C#1 is also called the cost of living inde4. *he rate of inflation is co&puted as a percentages change in the C#1 fro& one year to the ne4t. *he for&ula belo3 sho3s ho3 the rate of inflation is co&puted. 1nflation rateIC#1 this year5 C#1 previous yearR 100 C#1 previous year "or e4a&ple, given that the C#1 for the year 000 3as 1 1 and that for the year 001,110, the inflation rate using the above for&ula 3ould be 1nflation rate I 1 1 9 110R 100 110

Disinflation is a reduction in the rate of inflation. "or e4a&ple, if the inflation rate in the year 000 3as @ and in 001, 1.'@ , it sho3s a decrease in the inflation rate. Disinflation does not &ean that prices are falling but that at 3hich inflation is increasing is falling. 12. De&ree Of Inflation 17

1nflation can be distinguished based on the incre&ent of e general price level. Based on this concept, inflation can be grouped into + &ain degrees as belo3. 1. Moderate InflationG 7hen the rate of inflation rise by less than 10@ per annu& :single digit inflation rate;, it is 6no3n as /oderate 1nflation. 1t is a stable inflation and not a serious econo&ic proble&. 2. Cree"in& InflationG *his is also 6no3n as &ild inflation. *his type of inflation occurs 3hen the price level persistently gently rises over a period of ti&e at a &ild rate. *his happen 3hen prices rise by not &ore than :up to; !@ per annu& :year;. 3. Aallo"in& InflationG 1f &ild inflation is not chec6ed and if it is uncontrollable, it &ay assu&e the character of galloping inflation. *his happen if prices rise by the double or triple digit range of 0, 100 or 00 percent a year. '. /ta&flationG 1t is an econo&ic situation in 3hich inflation and econo&ic stagnation or recession occur si&ultaneously and re&ain unchec6ed for a period of ti&e. Ftagflation 3as 3itnessed by developed countries in 1.+0s, 3hen 3orld oil prices rose dra&atically. 1t is a condition 3hen a high rate of inflation happens at the sa&e ti&e that a high rate of une&ploy&ent e4ists. 1. ?y"erinflationG Cyperinflation refers to a situation 3here the prices rise at an alar&ing high rate. 1t is a stage of very high rate of inflation 3hen prices rise above 1000@ per annu& :<uadruple or four digit inflation rate. *he prices rise so fast that it beco&es very difficult to &easure its &agnitude. Co3ever, in <uantitative ter&s, During a 3orst case scenario of hyperinflation, value of national currency :&oney; of an affected country reduces al&ost to 8ero. #aper &oney beco&es 3orthless and people start trading either in gold and silver or so&eti&es even use the old barter syste& of co&&erce. 3. $e"ressed Inflation 1t is a condition 3hen the value of &oney or consu&er spending po3er decreases continuously. *his condition is not caused by an increase in prices, but by de&and bloc6ade by the govern&ent through rationing of goods and price controls. During a repressed inflation, the rate of inflation is not too high because it is continually &onitored by the govern&ent through certain regulations 5. DeflationG Deflation is the reverse of inflation. 1t refers to a sustained decline in the price level of goods and services. 1t occurs 3hen the annual inflation rate falls belo3 8ero percent :a negative inflation rate;, resulting in an increase in the real value of &oney. Japan suffered fro& deflation for al&ost a decade in 1..0s.

13. %y"e /Causes Of Inflation 18

1. Demand!Pull Inflation De&and5pull inflation is li6ely 3hen there is full e&ploy&ent of resources and aggregate de&and is increasing at a ti&e 3hen F(AF is inelastic.

De&and pull inflation is largely the result of the level of AD being allo3ed to gro3 too fast co&pared to 3hat the supply5side capacity can &eet. *his conditions is also 6no3n as >too &uch &oney chasing too fe3 goods>. *he result is e*cess demand for &oods and ser(ices and pressure on businesses to raise prices in order to increase their profit &argins. #ossible causes of de&and5pull inflation include consu&ption, govern&ent e4penditure, invest&ent and net e4port. 1f there is an increase in the AD 3hich e4ceeds the increase in goods and services supplied, prices 3ill increase. *he increase in aggregate de&and 3ill cause the econo&y to be in a state of full e&ploy&ent, unable to satisfy the continuous increase in de&and. *hus, 3hen the de&and e4ceeds supply, prices 3ill increase. 1t is caused by a rise in AD 3hich &ay be due to a rise in consu&er de&and, or an increase in the level of govern&ent e4penditure, or a rise in invest&ent by fir&s, or an increase in de&and for the country=s e4ports by people in foreign countries or a co&bination of the four.

2. Cost Push Inflation 19

Cost5push inflation is 3hen prices rise due to gro3ing cost of production of goods and services. 1t refers to an increase in the general price level associated 3ith an increase in the cost of production such as ra3 &aterials and 3ages. "or e4a&ple, if there is an increase in the prices of ra3 &aterials and other co&ponents used in the production processes of different industries. *his &ight be because of a rise in 3orld co&&odity prices such as oil, copper and agricultural products used in food processing. 2enerally, fir&s 3ill transfer the burden of the cost increase to consu&ers by increasing the selling price. *he fir&s respond to risin& costs, by increasing prices to protect their profit &argins. Fi&ilarly, inflation caused by 3age increases, 3hich are greater than i&prove&ents in productivity leads to a rising labour costs .7age costs often rise 3hen une&ploy&ent is lo3 :s6illed 3or6ers beco&e scarce and this can drive pay levels higher; and also 3hen people e4pect higher inflation so they bid for higher pay clai&s in order to protect their real inco&es. *his 3ill lead to the unit cost of production also increases. As a result, the prices of end5products or end5services being produced and supplied are conse<uently hi6ed. Cost5push inflation occurs 3hen resource prices rise une4pectedly, could cause both output and e&ploy&ent to decline. (eal inco&e falls.

3. Im"orted Inflation 20

1&ported inflation is caused by the increase in the price of i&ported goods 3hich consist of finished goods, partly finished goods and ra3 &aterials in the production process. Consu&ers have to pay a higher price if the i&ported goods face an increase in price. #roducers 3ill transfer part of the cost to consu&ers by increasing the selling price if the i&ported input goods undergo an increase in price. 1f a country i&ports goods fro& a foreign country, and the prices of i&ported goods increases due to inflation abroad, then the prices of do&estic products using i&ported goods also rises. *his is 6no3n as 1&port #rice5Ci6e 1nflation. "or e.g. /alaysia i&ports oil fro& 1ran at O100 per barrel. Oil prices in the international &ar6et suddenly increases to O1'0 per barrel. ?o3 /alaysia to continue its oil i&ports fro& 1ran has to pay O'0 &ore per barrel to get the sa&e a&ount of crude oil. 7hen the i&ported e4pensive oil reaches /alaysia , the &alaysian consu&ers also have to pay &ore and bear the econo&ic burden. /anufacturing and transportation costs also increase due to hi6e in oil prices. *his, conse<uently, results in a rise in the prices of do&estic goods being &anufactured and transported. 1t is the end5consu&er in /alaysia , 3ho finally pays and e4periences the ulti&ate pinch of 1&port #rice5Ci6e 1nflation. 1f the oil prices in the international &ar6et fall do3n then the i&port price5hi6e inflation also slo3s do3n, and vice5versa. '. /tructural Inflation Ftructural inflation occurs because a govern&ent pursues an e4cessively loose &onetary policy. *hat is, if a central ban6 prints too &uch &oney or 6eeps interest rates too lo3 for too long, the value of each unit of currency drops &ore than it 3ould si&ply fro& increased de&and. *his happen due to the changes in the structure of econo&ic syste& and the &is&anage&ent of a country=s &onetary policy.

1'. %he )ffect /ConseBuences Of Inflation 1nflation causes the general price level rises. *hus, the real inco&e of the population 3ill decline and to reduce the purchasing po3er of consu&ers. 1f the econo&y has reached full e&ploy&ent, inflation 3ill increase the general price level 3ithout increasing the total output. As a result, the cost of living increase and the standard of living declined. *his is because the a&ount of the sa&e, the <uantity of goods can be purchased decreases. Positi(e )ffects Of Inflation #ositive i&pact of inflation on the follo3ing: 5 #ositive -ffects Of 1nflation Internal "i4ed #roperty O3ner Fhareholders Business&anB #roducers Debtors BBorro3ers )*ternal *er& of *rade 1&prove

Positi(e )ffects Of %he Internal. 1. Fi*ed Pro"erty O0ners 21

1n ter& of distribution of inco&e, the people 3ho stand to gain fro& continuous inflation are property o3nersBreal estate o3ners such as land o3ners and shop o3ners. *his is due to the surge in prices of assets. During inflation, the value of i&&ovable property such as house, land and building 3ill increase. *his 6ind of savings in ter& of assets and real estate 3ill gain for e4a&ple, the prices of housing, je3ellery 3ill rise and the o3ners 3ill gain. 2. /hareholders Fhareholder 3ill gain because higher higher profits for co&panies 3ill &ean higher dividend because the share price 3ill rise 3hen inflation is &oderate. 3. Businessman/Producer 1n ter& of production and invest&ent, both producers and business&an gain fro& inflation. Businesses because higher prices than the increase in cost of production. *hus, the trader profits 3ill increase.During inflation, the general level of prices rises and producers &a6e higher profits, lead the producers to increase their level of production and invest&ent .Fince the inflation &ediu& to pro&ote invest&ent, national output 3ould increase by a factor of production used in full. As a result of national inco&e increases.*he people 3ho stand to gain fro& continuous inflation. Business&an 3ho earn higher profits fro& rising prices. 4. Debtor/Borro0er/Credit $eci"ient Profits Debtors 3ill gain because as they repay the loan,, it is less than the real value of the principal su&. *he si8e of the debt depreciated in value as result of inflation . 1nflation 3or6s to the advantage of debtors. Borro3ers benefit during period of une4pected inflation because the purchasing po3er of &oney borro3ed is less than the purchasing po3er of &oney repaid to lender. *he purchasing po3er of &oney borro3ed is greater than the purchasing po3er of &oney repaid to lender. *hose receiving credit, 3ill gain fro& inflation because the spending po3er of the &oney repaid is lo3er than the spending po3er at the ti&e of borro3ing. *hus, the lender i&poses an interest rate on the borro3er to cover the loss caused by inflation. Positi(e )ffects of )*ternal 1. Fa(ourable %erm of %rade /Im"ro(e *er& of *rade can be defined as the e4change rate of e4port for i&port, i.e, ho3 &uch of e4ports in e4change for a certain a&ount of i&port. Because of inflation in the country, the e4port prices to rise. 1f the factors do not change, the country>s ter&s of trade i&prove. 1n o 3e pay less for i&ports than for our e4ports. 1n other 3ords, our earnings rise for every unit of e4port so 3e can get &ore i&port. 1n &onetary ter&s, *his 3ill lead to favourable ter&s of trade. 1f e4ternal de&and for e4ports is not price elastic, the i&prove ter&s of trade due to inflation 3ill i&prove the country>s trade balance. +e&ati(e )ffects Of Inflation ?egative i&pact of inflation on the follo3ing: 5 ?egative -ffects Of 1nflation Internal "i4ed 1nco&e -arnersB#ensioner Bondholders Favers CreditorsBLenders +e&ati(e )ffects Of %he Internal. 1. Fi*ed Income )arners/Pensioner $etiree/Fi*ed 2a&e )arner 22 )*ternal Deficit Balance Of *rade Devaluation in -4change (ate

*hose 3ho receive a fi4ed inco&e, for e4a&ple, e&ployees 3ho receive a fi4ed 3age, pensioners and others 3ill suffer losses. *his is because inflation causes their real inco&e do3n. "i4ed5inco&e groups 3ill be hurt because their real inco&e suffers. *heir no&inal inco&e does not rise 3ith prices. 1ndividuals 3ho receive a fi4ed inco&e such as salaries and pensions 3ill face a loss if inflation happens. *his is because inflation reduces the individual=s real inco&e and the value of &oney. *hose 3ho do not o3n property such as the lo3er inco&e group 3ill find their real inco&e decreasing. Conse<uently, inflation 3ill increase the gap bet3een the differences in inco&es and thus 3orsen inco&e distribution 2. Bondholders Bondholders tend to lose in an inflation. *his is because during inflation, their real profit 3ill decrease because they earn fi4ed interest.*hose receiving fi4ed interest fro& bonds suffer losses during inflation. A retired business e4ecutive 3hose current inco&e co&es entirely fro& dividend fro& A&anah Faha& ?ational Berhad. 3. /a(ers All savings that has fi4ed value such as fi4ed deposits, insurance, &ortgage 3ill depreciates in ter&s of real inco&e. *he rising prices 3ill erode a3ay the purchasing po3er of such savings. *hose 3ho save the financial institutions suffered losses due to inflation lo3ers the real interest rate. (eal interest rate I no&inal interest rate 5 the rate inflasi,. 1f no&inal interest rates offered by financial institutions I 10@, inflation I )@, real interest rate I 10@ 5)@ I $@ only. Favers 3ill be hurt by unanticipated inflation, because interest rate returns &ay not cover the cost of inflation. *heir savings 3ill lose purchasing po3er '. Creditors/4enders *he creditors 3ill suffer losses due to the repay&ent of &oney they received 3hile inflation has declined. Debtors :borro3ers; can be helped and lenders hurt by unanticipated inflation. 1nterest pay&ents &ay be less than the inflation rate, so borro3ers receive SdearT &oney and are paying bac6 ScheapT dollars that have less purchasing po3er for the lender. 1ndividuals 3ho give loans to others 3ill face a loss because the &oney paid by the borro3er in the future 3ill have lo3 spending po3er o3ing to inflation. *hose receiving credit, 3ill gain fro& inflation because the spending po3er of the &oney repaid is lo3er than the spending po3er at the ti&e of borro3ing. *hus, the lender i&poses an interest rate on the borro3er to cover the loss caused by inflation. +e&ati(e )ffects Of %he )*ternal. 1. Deficit Balance Of %rade /any countries face a deficit balance of trade because i&port is greater than e4port, arises because i&ported products are no3 cheaper than do&estic products. "or e4a&ple, /alaysia is facing inflation but our neighbouring country, *hailand e4perience no inflation. *hai people 3ill not 3ant to buy fro& /alaysia. On the other hand, /alaysian 3ill find *hailand goods cheaper, hence they 3ill buy fro& *hailand. *his lead to /alaysia i&ports 3ill increase. 7hen i&ports e4ceeding e4ports, then the econo&y 3ill be facing deficit deposit. 7hen inflation occurs in the country, e4port prices beco&e &ore e4pensive. *hus reducing the total e4ports and thus 3orsen the country>s balance of pay&ents. 2. De(aluation in )*chan&e $ate "oreign e4change rates affected 3hen total e4ports declined due to inflation in the country. *his situation devaluing the currency in the country and led to the decline of foreign invest&ent. Other countries 3ill find the currency &ore e4pensive and hence, there 3ill be less de&and for it.*his 3ill eventually lead to a fall in the price of the currency. 1nflation devaluing &oney in the country 3ill increase foreign invest&ent abroad 11. Method to Control Inflation Monetary/Financial Policy %o Combat Inflation 23

/onetary policies 3hich consist of controlling the supply of &oney by the central ban6 are enforced by using the different &onetary instru&ents 3hich ai& at reducing the supply of &oney. By applying contractionary Nuantitative and Nualitative /onetary #olicy 3ill decrease &oney supply and credit creation hence decrease Aggregate De&and to stabili8e econo&ic situation and to control econo&ic inflation. Contractionary Duantitati(e Monetary Policy *here are various instru&ents or tools of &onetary policies 3hich the central ban6 e&ploys to achieve the goals of the econo&ic policy that is to co&bat inflation as follo3ing: 1. $aisin& Minimum $eBuirement Of /tatutory Cash $eser(e $atio nd 4iBuidity sset During inflation, the Central Ban6 3ill increase the rate of statutory reserve and &ini&u& li<uidity 3here the need for savings of financial institutions in the central ban6 3ill increase. "ollo3ing this, the li<uidity state of financial institutions 3ill decrease as this 3ould reduce the ability of ban6 or other financial inter&ediary to provide loans to the public and this has the effect of decreasing the &oney supply in the econo&y. Besides cash reserves, co&&ercial ban6s also have to 6eep li<uidated assets issued by Ban6 ?egara /alaysia :B?/; such as treasury bills and govern&ent securities. *he &ore re<uired li<uidated assets that are held, the lesser the credit that can be created. *he re<uired &ini&u& li<uidated assets are fi4ed by Ban6 ?egara /alaysia and are used as a &onetary policy tool to control the /alaysian econo&ic stability 2. /ell &o(ernment securities in O"en Mar#et O"eration 1n ti&e of inflation, the &oney supply has to reduced, the central ban6 3ill sell govern&ent securities such as short5ter& bonds or treasury bills to co&&ercial ban6s or to the public through the ban6s. *his results in transfer of a part of ban6 deposits to central ban6 account and reduces the cash reserve of the co&&ercial ban6s and reduced credit creation capacity of the co&&ercial ban6s. Che<ues are &ade payable to the central ban6. *he result is a decrease in consu&er e4penditure 3. Increase ban# rate and discount rate o"eration During inflation, a high the ban6 rate 3ill be i&posed by the Central Ban6 to reduce the loans to the ban6ing sector. *his 3ill lead to an increase the cost of borro3ing 3hich reduces co&&ercial ban6s borro3ing fro& the central ban6. *his is to reduce the &oney o3ned by financial institutions, thus reducing loans to the public. Conse<uently, the flo3 of &oney fro& the co&&ercial ban6s to the public gets reduced. *herefore, increase in the ban6 rate discourages borro3ing.7hen the rate of inflation is high, the central ban6 can also increase discount rate. 1f the ratios of discount rate are increased, the need for savings of financial institutions in the central ban6 3ill increase. "ollo3ing this, the li<uidity state of financial institutions 3ill decrease and this 3ill cause the financial institutions to reduce loans to the public. '. $aisin& Interest $ate *he govern&ent can increase the interest rate 3hen the inflation rate is high. *his is to encourage &ore &oney to be deposited in financial institutions rather than to be spent. *his 3ill prevent the rise of prices cause by consu&ption e4penditure of households. *he Central Ban6 &ay persuade co&&ercial ban6 to increase their rate of interest on deposit fro& the public. *his action fro& co&&ercial ban6 3ill increase the level of savings and decrease the purchase of goods and services fro& the public. "or e4a&ple, an increase of the interest rate on fi4ed deposits fro& $@ to 10@3ill result in consu&er saving &ore and spending less . *he high rate of interest 3ill attract and encourages &ore people to save and this 3ill increase the level of savings Consu&ers loo6 at interest rates as costs of loans. *he higher the interest rate is, the lo3er the 3ish of consu&ers to borro3. *he sa&e applies to loan re5pay&ent periods. *he shorter the re5pay&ent period, the consu&ers would be deterred to &a6e loans because they cannot afford to pay a higher &onthly install&ent.

24

1nterest rate can be used to influence the cost of borro3ing for consu&ption. A high interest rates &ight be seen as a re<uire&ent for controlling consu&er spending, so as to 6eep do3n the rate of inflation. 7hen &oney supply decrease, the interest rate 3ill increases. *his 3ill cause the savings to increases. but. discourage invest&ent and consu&ption. *he central ban6 raises interest rates 3hen it is trying to slo3 do3n the econo&y because of a fear of accelerating inflation. 1. Fundin&,fundin& buyin& lon&!term bonds"unding is a process by 3hich the govern&ent sells long5dated debt :national savings security; rather than short5 dated debt :treasury bills;. Fuccessful funding of the national debt &eans that the general public buy illi<uid securities, 3hich causes a fall in the general public=s deposits and effects the &oney supply. "unding operation return to the practice of &anaging the govern&ent debt in order to influence the &oney supply. *hese operations involve the replacing of &aturing debts 3ith longer ter& securities."unding is the central ban6 &easures to reduce the production of short5ter& govern&ent securities and increase the production of long5ter& govern&ent securities. *he central ban6 ta6e the action to reduce the circulation of &oney supply due to e4cess supply of &oney for the purpose of fighting inflation. Contractionary Dualitati(e Monetary Policy Contractionary Nualitative /onetary #olicy 3ill discourage ban6 to borro3 in order to control inflation. Nualitative policy ai&s at controlling and discouraging activities in specific econo&ic sectors. . /electi(e Credit Control Felective credit controls regulate the e4tension of credit for particular purpose. *ightening selective credit controls 3ill li&it certain types of spending. *he &ain purpose of perfor&ing selective credit control is to ensure that co&&ercial ban6s provide loans and &a6e invest&ents in accordance 3ith govern&ent aspiration. 1t is not intended to control the total a&ount of &oney created by co&&ercial ban6s through their lending and invest&ent activities but rather on the pattern of loan and invest&ent &ade by co&&ercial ban6s. *he Central Ban6 controls the granting of credits 3hich financial institutions give to the public or investors. During inflation, tightening selective credit controls 3ill li&it certain types of spending. Felective loan control specifies the types of loans 3hich have to be reduced or encouraged. i. %i&hten control on mar&in reBuirement

Control of &argin re<uire&ents li&it the volu&e of loans for purchase of shares. -4a&ple: 1f the &argin re<uire&ent is $'@, this &eans that individuals have to pay $'@ of the share price and the re&aining ''@ can be financed through ban6 loans. *herefore, deter&ination of the higher &argin re<uire&ents 3ill reduce the ability of people to buy shares through a loan. Fuch controls reduce the de&and for &oney for speculative purposes and to reduce inflationary pressures. ii. %i&hten control on credit mort&a&e

Control on credit &ortgage is control the loan on buying property through &ortgage. During inflation, the Central Ban6 to i&pose strict conditions li&iting &ortgage credit creation process to discourage public fro& buying the property and thus discourage &ortgage credit creation process for the public>s ability to obtain loans iii. %i&hten control on credit installment Control of activities on credit installment affecting purchasing goods trough loan or install&ent. During 1nflation, the stringent conditions of credit install&ent, such as raising the &ini&u& pay&ent and shorten the repay&ent period 3ill reduce the activities of credit purchases. i(. /"ecial directi(e

25

*he central ban6 3ill instruct co&&ercial ban6s to reduce the volu&e of loans given to the public. *he central ban6 3ill also influence co&&ercial ban6s to restrict their lending policy such as the need for collateral security, guarantors and other &easures, 3hich 3ill discourage borro3ings. b. Moral Persuasion *his is done by central ban6 3hen &eeting 3ith representatives of co&&ercial ban6s. 1n the &eeting, central ban6 3ill e4plain the econo&ic and financial state of the country and as6 the co&&ercial ban6s to ta6e certain steps to overco&e any financial and econo&ic proble&s faced. *he granting of credits should give priority to i&portant develop&ent projects 3hich re<uire financial assistance. Conversely, loans for speculation purposes and e4penditure on lu4urious goods are not encouraged. *his strategy focuses on the direction of loans given by the co&&ercial ban6s. %sually the ban6ing sector is not interested in giving loans to the agricultural sector, food producers and s&all and &ediu& si8ed industries. *herefore, central ban6s can as6 co&&ercial ban6s to allocate certain funds to be given to these loan see6ers in productive sectors. Fiscal Policy to combat Inflation Contractionary Fiscal Policy or /ur"lus Bud&et Policy *he contractionary fiscal policy or 6no3n as surplus budget policy is practiced by the govern&ent during inflation. *he &ain ai& is to control the e4cessive de&and that causes the general price level to increase. *he govern&ent can i&ple&ent a contracting fiscal policy during inflation, 3hich is by increasing ta4es or reducing govern&ent e4penditure or both. 7hen ta4es are increased and govern&ent e4penditure is reduced, aggregate de&and 3ill drop, and thus prevent the increase in the price of goods and services. 1. Decreasin& Ao(ernment )*"enditure A reduction in govern&ent e4penditure 3ill directly affect aggregate de&and. *he govern&ent 3ill cut the salary of all civil servants and postpone its develop&ent project to reduce the purchasing po3er of the public. A decrease in govern&ent spending and an increase in the govern&ent=s total ta4 revenue 3ill produce a surplus budget. . 4o0erin& %ransfer Payment Decreasing transfer pay&ent, for e4a&ple, decreasing pay&ent to those affected by recession is another strategy as they 3ill no3 have less &oney in their poc6et thus reduce their spending 3hich 3ill eventually decrease aggregate de&and in the econo&y. !. Increasin& %a* By increasing direct :not indirect; ta4es, aggregate de&and 3ill drop and thus prevent the increase in the price of goods and services. Conse<uently, the people=s disposable inco&e of individuals 3ill fall and their consu&ption of goods and services. . *his &eans that there 3ill be a fall in de&and, and 3ith falling de&and, prices 3ill fall, ceteris paribus. A highly regressive ta4 structure can successfully reduce the i&pact of inflation on the econo&y. Direct Control Policy to combat inflation
Direct Control /easures is govern&ent intervention on econo&ic activities to ensure fiscal policies and &onetary

reconsideration 3ill be effective in controlling inflation. Direct control e4ercised by the govern&ent include the follo3ing. Measures %o O(ercome Demand Pull Inflation: 1. Price control Controlling the #rice of Certain 2oods 3here the govern&ent can i&ple&ent a ceiling price policy, 3hich sets the &a4i&u& price for certain goods. *his 3ill prevent sellers fro& selling the goods at a higher price than stipulated. As such, producers 3ill no t be able to increase price according to their 3ishes. *he govern&ent 3ill control the prices of goods by fi4ing a floor price and a ceiling price. 2. $ationin& 26

At the ti&e of inflation, govern&ents can control purchasing of essential good by i&ple&enting policies through rationing. (ationing can be done by issuing coupons to the public 3here consu&ers can purchase li&ited goods and services using coupon. *otal goods to be purchased is li&ited to the a&ount stated on the coupon. *his policy guarantees that the goods 3ere obtained also by the needs of the poor group. 3. nti!hoardin& cam"ai&n

*his arises 3hen reports are &ade against producers and consu&ers 3ho store goods unnecessarily because such storing can cause an artificial shortage and push prices up. '. Com"ulsory sa(in&s *o control inflation, it is essential to introduce a co&pulsory savings plan. *his could be by 3ay of a deduction fro& the salary of 3or6ers that is credited to 3or6ers= accounts. 1n /alaysia, this body is 6no3n as the -&ployees #rovident "und :-#"; 3here 11@ of the 3or6ers= 3ages are deducted every &onth. *he a&ount credited into the 3or6ers= savings account can only be 3ithdra3n upon retire&ent. 1. Increase the "roduction of neccesities &oods At the ti&e of inflation govern&ents can provide the econo&ic resources of the e4cessive output of goods less i&portant. 2overn&ent can underta6e the &anufacturing of essential ite&s so that people can enjoy the output. Fo, the output level of the essential ite&s can be increased and the prices 3ill be controlled. Measures %o O(ercome Cost Push Inflation: 1. Controllin& the increase of salary and 0a&es Controlling the increase of salary and 3ages in the &ar6et too can assist in the efforts to control inflation. 1f 3ages and salaries are not raised, the cost of production and household inco&e 3ill not increase. *hus, producers are not inclined to increase prices. On the other hand, the constant rate of salary of e&ployees reduces the pressure of price increase. %nion clai& increase in 3ages 3hen econo&y has reached full e&ploy&ent is not in line 3ith productivity 3ill increase production costs. *herefore, the govern&ent can i&ple&ent &a4i&u& 3ages policies to control the continuous incre&ent. 7age controls intended to curb &anufacturers rising the production costs. *he govern&ent could also negotiate 3ith trade unions to control 3age increases. 2. Controllin& "rices of ra0 material 1ncrease in the price of crude or fuel 3ill increase production costs for fir&s. *he prices of final product 3ill go up as input prices 6eep on rising. *o control the price of ra3 &aterials, the govern&ent &ay declare the ra3 &aterials as a controlled ite&. *he govern&ent could also subsidi8e the production of ra3 &aterials so that the ra3 &aterials are no3 available at a price lo3er than the e<uilibriu& price. 3. $eduction of im"ort ta* on intermediate &oods *he i&ports of inter&ediate goods is /alaysia>s &ost i&portant and the percentage of the total i&ports has increased as a result of the rapid develop&ent of &anufacturing industry. (eduction or e4e&ption of i&port ta4 on ra3 &aterials, co&ponents, &achinery and e<uip&ent fir&s 3ill reduce production costs and reduce cost5push inflationary pressures. '. )ncoura&e the de(elo"ment of technolo&y and labor "roducti(ity *a4 incentives given to the creative and innovative fir& to pro&ote technological develop&ent and i&prove the efficiency and labor productivity. *his 3ill surely 3ill reduce production costs. 7hen the production costs fall , the aggregate supply curve 3ill shift fro& left to right. 1ncreasing output by ta4 incentive, encouraging research and develop&ent and giving grants tio fir&s 3ho invest in better technology. Measures %o O(ercome Im"ort Push Inflation: 27

1. Controllin& of "rices of consumer &oods 2overn&ent intervention to control prices of i&ported consu&er goods, especially prices of food such as sugar and beef. 2overn&ent 3ill set the policies on &a4i&u& price for consu&er goods that are included as a controlled ite&. #rior to that, the producers &ust obtain per&ission fro& the govern&ent to raise the price. 2. Promotin& im"ort substitution industries *o reduce dependence on i&ported goods, the govern&ent can ta6e the steps to diversify the econo&y and encourage the develop&ent of i&port substitution industries. Develop&ent of i&port substitution industries to be &ore self5reliant and less dependent on foreign countries for industrial &aterials. 3. Increasin& the local "roducts to reduce im"orts /easures to increase agricultural production to not only reduce the current account deficit, but also address the proble& of inflation, particularly rising prices of i&ported food. By increasing local food production 3ill lead to reduce dependence on i&ported food that is vulnerable on the ris6 3ith regards to international price. '. Di(ersifyin& sources of im"orts 2overn&ent and &anufacturers &ay see6 to find source of i&ports 3hich is relatively cheaper in order to overco&e the proble& of i&ported inflation."or e4a&ple, for i&ported goods on food and agricultural inputs that cannot be produced locally, there &ust be an efforts to diversify sources of i&ports, particularly in ter&s of finding the cheapest one. 1. /tren&thenin& currency (alue to reduce the cost of im"orts Despite the appreciation of the currency could affect the co&petitiveness of e4ports, but the value of a strong national currency can also reduce the cost of i&ported goods, especially ra3 &aterials and fuel. 13. Inflationary Aa" (s Deflationary Aa" 1nflationary gap occurs 3hen aggregate de&and :AD; e4ceeds aggregate supply :AF; at full e&ploy&ent level of output. 1n this case, &oney inco&e rises to a higher e<uilibriu&, but real inco&e :being at full e&ploy&ent output level; re&ains unchanged. As a result, there is an up3ard rise in prices because the consu&ers co&pete for li&ited supply of output and bid prices up. 1n other 3ords, inflationary gap reflects that at full e&ploy&ent level of output, real inco&e cannot rise, but the prices rise to the e4tent that AD E AF at full e&ploy&ent. 1nflationary gap continues to prevail until either AD contracts to the level consistent 3ith the full e&ploy&ent level or AF is e4panded through econo&ic gro3th. 7hen the e<uilibriu& level of output is greater than the natural rate, an Inflationary A P e4ists. *his is illustrated above, 3here the e<uilibriu& level of output, D, e4ceeds the natural level of output, Dn. 7hen the econo&y e4periences an inflationary gap, a Contractionary Fiscal Policy, such as a decrease in govern&ent spending or increase in ta4es, or a Contractionary Monetary Policy is appropriate. *hese policies shift the AD curve to the left.

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An inflationary gap can be defined as a situation 3here national inco&e is in e4cess of the full e&ploy&ent level Df e. *he increase is only in the increase in general price level but not real increase. 1t can be caused by e4cess de&and. 7hen aggregate de&and C U1 U2 U:V 5/ ; e4ceeds full e&ploy&ent level ,there is inflation 1n the injection5 3ithdra3al &odel, inflation occurs 3hen total injections e4ceed total 3ithdra3al at D e . *o close the inflationary gap there &ust be a contractionary policy. 7ithdra3al &ust be increased and injections reduced. Calculation on Inflationary Aa" Belo3 sho3s the Aggregate -4penditure on econo&y having an inflationary gap Duestion 1. DIAA-I '0 U0.,D A- f

1000 1 '0 D 2iven D at full e&ploy&ent is at 1000, ho3 &uch the inflationary gap. ns0erG /ultiplier I 1 I 1 I ' 15/#C 150., 2ross ?ational #roduct 2ap I (eal D 9 D at full e&ploy&ent I 1 '0 9 1000 I 219 *herefore,1nflationary 2ap I 2ross ?ational #roduct /ultiplier I '0 I 19 ' Duestion 2 2iven A- function :A- I!00 U 0.+'D. and Aggregate -4penditure function at full e&ploy&ent : A- f I 1 0 U0.+'D Co3 &uch the 2ross ?ational #roduct 2ap ns0erG /ultiplier I 1 I 1 I $ 15/#C 150.+' 1nflationary 2ap I A-9 A- f I:!00 U 0.+'D; 9:1 0 U0.+'D ; I1,0 2ross ?ational #roduct 2ap I 1nflationary 2ap 4 /ultiplier I 1,0 4 $ I Deflationary Aa": 29

529

Deflationary gap prevails 3hen aggregate de&and :AD; is less than aggregate supply :AF; at full e&ploy&ent level of output. 1n this case, inco&e e<uilibriu& occurs 3hile so&e resources are une&ployed. 1n other, 3ords, deflationary gap depicts une&ploy&ent situation attributable to the fact that at full e&ploy&ent level of output, AD GAF. *hus, deflationary gap is &easured as the difference bet3een AD and AF at full e&ploy&ent, Deflationary gap, and the resultant conditions of une&ploy&ent and sluggish econo&ic activity, 3ill persist until a higher level of aggregate de&and consistent 3ith full e&ploy&ent is achieved. 1n "igure B, Df represents full e&ploy&ent output. *he position of AF line :i.e., $' 9 line; is such that at D" AD is less than AF by the a&ount BA. *hus, BA is the &easure of deflationary gap, 3hich is the sa&e thing as deficient de&and &easured at Df. 7hen the e<uilibriu& level of output is less than the natural rate, as sho3n belo3, a Deflationary A P e4ists. 1n the figure, the e<uilibriu& level of output, D, is less than the natural level of output, Dn. A deflationary gap calls for an )*"ansionary Fiscal Policy, such as an increase in govern&ent spending or reduction in ta4es, or an )*"ansionary Monetary Policy. Fuch an e4pansionary policy shifts the AD curve to the right and increases the e<uilibriu& level of real 2D#.

A deflationary gap can be defined as a situation 3here the e<uilibriu& level of national inco&e is not at full e&ploy&ent level. (esources are not fully utili8ed and any increase in national inco&e is a real increase. 7hen aggregate de&and C1U11U21U:V15/1; is belo3 full e&ploy&ent level ,there is a deflationary gap 1n the injectionW3ithdra3al &odel, a deflationary gap occurs 3hen total 3ithdra3als are greater than total injections. *o close the deflationary gap there &ust be an e4pansionary policy. 1njections &ust be increased and 3ithdra3als reduced. 1nflationary 2ap Deflationary 2ap Fi&ilarity Difference 1t happens 3hen the aggregate supply differs fro& the aggregate de&and happens 3hen the aggregate de&and happens 3hen the aggregate de&and is less than the is &ore than the aggregate supply aggregate supply.

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Calculation on Deflationary Aa" Duestion 1. DIAA- f A-I '0 U0.,D

1 '0 ns0erG /ultiplier I 1 I 1 I ' 15/#C 150.,

1'00

2iven D at full e&ploy&ent is at 1'00, ho3 &uch the deflationary gap.

2ross ?ational 2ap I D at full e&ploy&ent 9 (eal D I 1'00 9 1 '0 I 219 *herefore,Deflationary 2ap I 2ross ?ational 2ap I /ultiplier I 19 Duestion 2 2iven A- function :A- I1 0 U0.+'D and Aggregate -4penditure function at full e&ploy&ent : A- f I !00 U 0.+'D. Co3 &uch the 2ross ?ational 2ap ns0erG /ultiplier I 1 I 1 I $ 15/#C 150.+' '0 '

Deflationary 2ap I A- f 5 AI:!00 U 0.+'D; 9:1 0 U0.+'D ; I1,0 2ross ?ational 2ap I Deflationary 2ap 4 /ultiplier I 1,0 4 $ I + 0

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