Both the GDP and the CPI numbers for Malaysia were released yesterday.
Real GDP growth grew by 5.4% in the second quarter from a year ago. Although I suspected that growth would be strong due to strong showing in the industrial production index, I found 5.4% as surprising still. It was too strong for whatever the production index was showing.
The strong growth, along with low unemployment rate, provides a puzzle when it is considered together with inflation trend. Inflation in Malaysia, both headline (1.4% in July from a year ago) and core (1.3%) inflations, has been decreasing since the beginning of the year. Typically, strong growth creates demand-pull inflation. That demand-pull inflation has been absent in the second quarter despite strong GDP showing.
Furthermore, the unemployment rate has been low and I tend to consider the current rate to be quite close to the idea of full employment. The latest employment rate, which is for the month of May, is 3.0%. Previously, the rate hovered between 3.3% and 3.1%. Labor participation rate is also quite high given historical standard. The assumption of full employment implies the economy has been working close to its full potential. Any growth stronger than the potential will put upward pressure on prices.
Yet, inflation, especially core inflation, has been decreasing throughout the year.
This may suggest that the potential output is higher than the growth the Malaysian economy has been experiencing so far. It also suggests that the already low unemployment rate can go down further and that we are not really that close to full potential.
So, Malaysia can grow faster still, which is an exciting realization. I heard of the go-go 1990s. Maybe, it is time for the go-go 2010s in spite of everything. Let us just hope things will not go down in flame like it eventually did in the 90s.
Whatever it is, if growth so far has been unsustainable, then inflation should accelerate in the near future. If it is sustainable (i.e. actual growth is lower than potential), we should see only limited demand-pull inflation.
Finally, I previously projected the Malaysian economy to grow by 4.0% for the whole of 2012. I am looking like a fool now and will be looking to upgrade the growth rate soon. Nevertheless, I am ultimately skiddish about that upgrade. Although domestic demand, which grew by 12.0% year-on-year, has proven to be capable of cushioning the adverse impacts from weak exports, the global risk is still there. Trade has not collapsed but it can and if it does, an upgrade will be a very foolish thing to do.
4 replies on “[2579] Far higher potential output for Malaysia?”
[…] that the Malaysian economy is working near its limit although I have a lingering suspicion that the limit is farther out still), despite the estimates-expectations divergence. […]
Problem – when looking at aggregates, you’re necessarily smoothing over issues of product substitution in meeting demand. Right now what’s in demand is construction related goods and machinery. Our trade surplus is built on commodities and electronics. An oleo refinery isn’t going to start producing cement mixers. So its possible to have both spare capacity and inflation, or no spare capacity and deflation. It depends on the components of demand relative to what the economy can supply.
Then there’s the weird stuff like the fact that we produce crude oil, but all our petrol is imported. In a globalised world, supply chains are fragmented across economies.
Given that we’re looking at higher investment demand and not just higher consumption demand, I’m keeping a closer eye on the PPI rather than the CPI.
Yes, I forgot imports.
That explains the expanding SRAS. A friend and I were trying to figure this in terms of AD and SRAS and he noted that the only way inflation could slow down with an expanding AD was with an expanding SRAS. We had trouble rationalizing an expanding SRAS, especially given tight labor market. Imports allow the expansion of SRAS by increasing supply. So, that’s solved.
Thanks.
But there’s a possibility that potential output is higher, i.e the LRAS is somewhere farther out there. I’m saying this because while imports have increased tremendously so far, we’re still in trade surplus. Trade surplus is under pressure but the surplus essentially say there is still some spare capacity in the domestic economy. If there wasn’t, then we should be in deficit. What do you think?
*cough* imports *cough*
If demand is above potential, there are two responses – either inflation (closed economy) and/or higher imports (open economy). It depends on the substitutability between domestic goods and imported goods. We are in essence borrowing capacity from abroad, of which there is plenty.
Check the historical data from the 1990s – we were running a trade deficit during the peak investment years.