The Najib administration is committed to long-term reduction of subsidy. The Prime Minister said so.

I do support reduction and even elimination of subsidy. There are exceptions, but I do support anti-subsidy policy generally. So, I do take comfort from the Prime Minister’s statement.

Yet that does not mean I would support however the reduction is done. This is due to my concern for inflation expectations.

The Najib administration’s commitment to gradual reduction of subsidy is something that should be inspected closely. Gradual is the key word because the rate will create sustained inflation expectations. Inflation expectations itself will affect actual inflation in a big way.

It is not at all a problem if the gradual liberalization involves only small yearly increases. Such small increases will create limited inflation expectations. And a low inflation rate — as the economic wisdom goes and what goldbugs failed to understand — greases the economy.

But as I have shown earlier, sugar prices have increased by about 28% per year in the past two years. Other subsidized items like fuel that contribute to the Consumer Price Index have yet to be accounted for.

A sustained inflation expectation at that rate can be disastrous to the economy. I do not think anybody would want to see the Bank Negara playing a catch-up game with its monetary policy.

To prevent the sustaining of high inflation expectations, the rate of liberalization just has to slow down.

Alternatively, the government can eliminate all subsidies once and for all. That will create a one-off inflation. Yes, this is a crazy policy option but at least the inflation expectations will not be as bad as it is developing into right now. A one-off inflation spike is better than a sustained high inflation expectation because it will not leave a mark on the economy in the long run.

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