Wednesday, December 3, 2008

Fuel price and inflation

Being a student of finance and economics (well I can say that I am a graduate now), I follow closely the development of inflation in Malaysia. In an interview with AlJazeera few days ago, DPM Dato's Seri Najib expressed his disappointment that the retailers do not reduce the price of goods even though the government has reduced the fuel price.

I have warned in my previous post that in deciding to increase the fuel price by 70 cents, the government may have underestimated the price stickiness factor. Most of the economists understand that price stickiness is always asymmetrical. That is, it's easier to increase rather than decrease. While I understand DPM's disappointment, I would not say that retailers should take all of the blames. The government has made it worse in constantly reminding that the fuel price might increase again in the future. This might spark expectation that the operating cost will increase again hence induce retailers to lock in profit during this time, thus explain why prices are sticky.

I agree with the notion that fuel price (especially petrol) should be floated, rather than set by a committee who meet once in 2 weeks. The government is no longer subsidising petrol, hence there is no different between the two systems. Besides, all of the benefits can be passed immediately to consumers. Even if the global fuel price increase, the retail price per litre would not increase more than 20cents. Hence this system would prevent the price from increasing by 70 cents again!

There might be complaints by suppliers about the volatility of their supplies, but looking at how well the system is implemented in New Zealand, I do not see it will cause a significant problem to them.

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