A new look at asymmetric effect of oil price changes on inflation: Evidence from Malaysia

Abstract

The existing literature that examined the effect of oil price on domestic price inflation only focused on consumer price at an aggregate level. The studies that focused on producer and production levels, and based on disaggregated data are very lack. Besides, previous studies also mainly applied the linear regression approach in studying the effect of oil price. This study seeks to explore the mentioned issues by focusing on sectoral consumer (CPI), industrial (IPI), and producer (PPI) prices of Malaysia. The Markov-switching (MS) regression technique is applied. The models are innovated by incorporating the asymmetric effects of oil price changes. The results reveal different reactions of sectoral domestic price inflation to oil price changes. The oil price has asymmetric effects on domestic price inflation with higher impacts on industrial and producer prices than the consumer price. The effect is larger in sectors that have higher linkages with oil/ energy resources. These sectors are oil-intensive and are sensitive to oil price changes. Among these sectors are the CPI transportation sector, IPI manufacturing, and electrical sectors as well as PPI fuel, chemicals, and manufacturing sectors. However, oil is not the main factor causes to domestic inflation. The main determinants of inflation are real exchange rate, aggregate supply, and demand. Besides, the policy decisions are also influential on price stability. The sectors of CPI transportation, PPI animals & vegetable oils, and PPI fuel have a high tendency to increase prices and should be well-monitored.