Module 5. Activity 1.

1. What is inflation? 
Inflation is a sustained rise in overall price levels. Moderate inflation is associated with
economic growth, while high inflation can signal an overheated economy. As an economy
grows, businesses and consumers spend more money on goods and services.

2. How is inflation measured? 

In the U.S., the Consumer Price Index (CPI), which reflects retail prices of goods and services,
including housing costs, transportation, and healthcare, is the most widely followed indicator,
although the Federal Reserve prefers to emphasize the Personal Consumption Expenditures
Price Index (PCE). This is because the PCE covers a wider range of expenditures than the CPI.
The official measure of inflation of consumer prices in the UK is the Consumer Price Index (CPI),
or the Harmonized Index of Consumer Prices (HICP). In the Eurozone, the main measure used is
also called the HICP.

3. What causes inflation?

Inflation is a measure of the rate of rising prices of goods and services in an economy. Inflation
can occur when prices rise due to increases in production costs, such as raw materials and
wages. A surge in demand for products and services can cause inflation as consumers are
willing to pay more for the product.

4. How can inflation be controlled? 

Central banks, such as the U.S. Federal Reserve, European Central Bank (ECB), the Bank of Japan
(BoJ) or the Bank of England (BoE) attempt to control inflation by regulating the pace of
economic activity. They usually try to affect economic activity by raising and lowering short-
term interest rates.
Lowering short-term rates encourages banks to borrow from a central bank and from each
other, effectively increasing the money supply within the economy. Banks, in turn, make more
loans to businesses and consumers, which stimulates spending and overall economic activity.
As economic growth picks up, inflation generally increases. Raising short-term rates has the
opposite effect: it discourages borrowing, decreases the money supply, dampens economic
activity and subdues inflation.

5. How does inflation affect investment returns? 

Inflation poses a “stealth” threat to investors because it chips away at real savings and
investment returns. Most investors aim to increase their long-term purchasing power.
Inflation puts this goal at risk because investment returns must first keep up with the
rate of inflation in order to increase real purchasing power. For example, an
investment that returns 2% before inflation in an environment of 3% inflation will
actually produce a negative return (−1%) when adjusted for inflation.

If investors do not protect their portfolios, inflation can be harmful to fixed income
returns, in particular. Many investors buy fixed income securities because they want a
stable income stream, which comes in the form of interest, or coupon, payments.
However, because the rate of interest, or coupon, on most fixed income securities
remains the same until maturity, the purchasing power of the interest payments
declines as inflation rises.

6. How can i help protect my fixed income portfolio from inflation?

To combat the negative impact of inflation, returns on some types of fixed income securities
are linked to changes in inflation:

• Inflation-linked bonds issued by many governments are explicitly tied to changes in inflation.
In the 1980s, the U.K. was the first developed country to introduce “linkers” to the market.
Several other countries followed, including Australia, Canada, Mexico and Sweden. In 1997, the
U.S. introduced Treasury Inflation Protected Securities (TIPS), now the largest component of the
global ILB market.
Activity 2. 

ESSAY 

1. What is the impact of the current oil price shock on ASEAN countries? 

In particular: 
Through 2004 to 2006, the ASEAN countries were hit by the largest oil price increases since the
1970s. ASEAN countries are far more oil intensive in production than other countries and hence
more sensitive to oil price increases. They are also, as a group far more trade intensive than other
economies and highly integrated into global production chains. Consequently, the impact of oil
price shocks on the ASEAN economies could potentially be very large, even though the present
shock has only been modestly disruptive to growth.

This paper looks at the impact of the present oil price shock on the ASEAN economies,
examining the channels of transmission both direct and indirect, and examining why the
experience of the current oil price shock has been different to the experience of previous shocks,
(and why future oil shocks might be different again). In doing so, it looks at how the oil price
shock has impacted on the world economy and why there have only been relatively modest
effects on inflation, activity and interest rates this time around. The experience of the oil price
shock more broadly also provides some valuable policy lessons particularly in relation to the
importance of having well established medium-term frameworks for monetary and fiscal policy,
and well anchored inflation expectations. The paper then goes on to examines fiscal and
monetary responses to the impacts of higher oil prices, and how appropriate policy response to
the shocks differs according to the circumstances of different types of country.

2. What impact do the rising oil prices have in the short and long terms? 

In the 2000s, before the global financial crisis of 2008 and 2009, explosive economic growth
coincided with dramatic increases in global oil prices. This observation served to form the
common opinion that higher oil prices boost economic growth. However, in the current
economic situation in 2013 and 2014, when oil prices are higher than the long-term annual
average over the past decade, the growth rate in output is critically low; consequently, a simple
extrapolation of the events of the early 2000s may lead to a misinterpretation of the current
economic situation, to conceptually controversial forecasts of future economic development and,
as a result, to inefficient economic policy.

Discussion of the correlation between output growth in the Russian economy and oil prices
should be based on a formal economic and mathematical construct and built upon basic models
of economic growth. Otherwise, a purely qualitative and empirical analysis of current events
over a very short time span may produce conclusions and econometric dependencies that are
inconsistent with economic theory

3. What are the key transmission mechanisms of an oil price shock to 
ASEAN economies and what are the direct and indirect effects?  

Oil price shocks affect macroeconomic performance in both oil-importing and oil-exporting
countries. The recent research on the oil-macroeconomy relationship in the oil-importing
countries shows that oil price shocks have asymmetric effects on their economic growth; the
adverse effects of higher oil prices are larger than the stimulating effects of lower prices. The
effects of oil price shocks on economic performance and their transmission mechanism in oil-
exporting countries are different than those in oil-importing countries. In this study, we examine
the oil-macroeconomy nexus in the context of oil-exporting developing countries. We set up a
VAR model with a GARCH-type oil price shocks to estimate and test the asymmetric effects of
oil shocks in six major oil exporting members of OPEC for the period 1970-2009. The model
includes oil price shocks and economic growth as two major variables of interest as well as the
intermediate variables such as investment, exchange rate, and inflation rate. We find that in oil
exporting developing countries, lower oil prices would lead to major revenue cuts and stagnation
in the economy. However, higher oil prices and accompanying higher revenues do not translate
to a sustained economic growth.
4. What are the appropriate fiscal and monetary policy responses to that 
shock? 

Through 2004 to 2006, the ASEAN countries were hit by the largest oil price increases since the
1970s. ASEAN countries are far more oil intensive in production than other countries and hence
more sensitive to oil price increases. They are also, as a group far more trade intensive than
other economies and highly integrated into global production chains. Consequently, the impact
of oil price shocks on the ASEAN economies could potentially be very large, even though the
present shock has only been modestly disruptive to growth.

For example: • How have policies reacted in the past and how effective have the
responses been? 

5. How should monetary and fiscal policies in ASEAN economies best respond to these
oil price fluctuations and a sustained increase in oil prices?

The recent drop in prices is a significant, but not an unprecedented event as it has
some significant parallels with the price collapse in 1985-86. The recent decline has
been driven by a number of factors: several years of upward surprises in the production
of unconventional oil; weakening global demand; a significant shift in OPEC policy;
unwinding of some geopolitical risks; and an appreciation of the US dollar. Although the
relative importance of each factor is difficult to pin down, OPEC’s renouncement of price
support and rapid expansion of oil supply from unconventional sources appear to have
played a crucial role since mid-2014. The oil price drop will lead to substantial income
shifts from oil exporters to oil importers resulting in a net positive effect for global activity
over the medium term. Although several factors could counteract its impact on global
growth and inflation, the drop in oil prices will pose significant challenges for monetary,
fiscal, and structural policies.
Name:_Idyelle Princess S. Malimban_______________________________
Section Code/Year: _B475 3-J___________________________________
SELF-EVALUATION 
 
After reading the recommended references in the Warm-up Section, evaluate yourself by
placing a mark on the column that best describes your ability to comprehend the concepts.
There are no wrong answers in this section, so answer as objectively as possible. 
  Usually  Sometimes  Seldom  Never 
3  2  1  0 
 
 
I am able to grasp that when economic growth
     
begins to slow, demand eases and the supply of √
goods increases relative to demand 

 
I avoid confusing that heating oil prices also rise,
       
hurting both consumers and businesses. √
 
I learn the Moderate inflation is associated with
       
economic growth, while high inflation can signal an √
overheated economy
 
 
I understand that the Inflation-linked bonds issued
       
by many governments are explicitly tied to changes √
in inflation
 
 
I learn that the Many commodity -related assets can
       
also help cushion a portfolio against the impact of √
inflation because their total returns usually rise in an
inflationary environment 

 
I also learned that oil, rising wages can also cause
       
cost-push inflation, as an depreciation in a country’s √
currency

         
TOTAL  17
REFLECTION LOG 
MONETARY POLICY AND FISCAL POLICY 
Topic: Inflation in Emerging and Developing Economies Evolution, Drivers
and Policies
Student Name: Idyelle Princess S.
Malimban____________________________
Purpose: Student monitors their learning  through reflection prompts.  The log
documents growth and learning overtime  in the student’s words.  The log is used as
feedback on the topics being  discussed   and student learning  on the subject matter. 

Reflection Prompts  Reflection Logs  Remarks/ 

Suggestions 
   In this topic, I learned  
1. In     this     topic,     I     learned that………… that Inflation is a sustained rise
in overall price levels.
Moderate inflation is associated
with economic growth, while
high inflation can signal an
overheated economy. As an
economy grows, businesses and
consumers spend more money
on goods and services.

In the growth stage of an

economic cycle, demand
typically outstrips the supply of
goods, and producers can raise
their prices. As a result, the rate
of inflation increases. If
economic growth accelerates
very rapidly, demand grows
even faster and producers raise
prices continually. An upward
price spiral, sometimes called
“runaway inflation” or
“hyperinflation,” can result.
There are several regularly
reported measures of inflation
that investors can use to track
inflation. In the U.S., the
Consumer Price Index (CPI),
which reflects retail prices of
goods and services, including
housing costs, transportation,
and healthcare, is the most
widely followed indicator,
although the Federal Reserve
prefers to emphasize the
Personal Consumption
Expenditures Price Index
(PCE). This is because the PCE
covers a wider range of
expenditures than the CPI. The
official measure of inflation of
 consumer prices in the UK is
the Consumer Price Index
(CPI), or the Harmonized
Index of Consumer Prices
(HICP). In the eurozone, the
main measure used is also
called the HICP.

    The most useful thing in  

2. The most useful thing in this topic this topic was How inflation
was…………………..  affect investment returns?
Inflation poses a “stealth” threat
to investors because it chips
away at real savings and
investment returns. Most
investors aim to increase their
long-term purchasing power.
Inflation puts this goal at risk
because investment returns
must first keep up with the
rate of inflation in order to
increase real purchasing power.
For example, an investment that
returns 2% before inflation in
an environment of 3% inflation
will actually produce a negative
return (−1%) when adjusted for
inflation.

   The main thing I want to  

3. The main thing I want to find out more find out more about is how
about is…………………….  can citizens specifically help
  to reduce inflation.

   I might have learned more  

4. I might have learned more  from this lessons if there
from     this     lessons  if……………  are more in depth explanation
on some areas.

5. One thing when I am not sure about.   One thing when I am not  
  sure about is the fixed
income portfolio from
inflation.
Instruction: Log in your  reflections on the spaces provided following the prompts.  Submit a
copy as a formative evaluation and retain a copy for you to compile as p