Financial Policies and their Role in Facing Inflation in Oil-Producing Countries
Table of Contents
Introduction and Background. 3
Introduction and Background
Households prefer financial stability with permanent employment as well as stable income so that consumption remains stable over time. Notably, unnecessary fluctuations in the economy can reduce growth in a country, for instance, by increasing investment risk. Financial policy contributes to economic growth and social welfare by maintaining a healthy macroeconomic environment. The financial policy includes laws on financial and payment structures in the field of financial control, supervision and monitoring, to foster financial stability, productivity in markets, and consumer security. Financial policies are essential to ensure the smooth running of any company and governmental institutions. Financial plans and processes help ensure professional handling of a government agency. The goal is to direct the government in the long run and to direct decision making (Temin, 2016).
Inflation is the rate estimate at which the overall price level of the goods and services listed rise over time. It is the overall increase in the price level when a currency unit buys less than before. In determining economic conditions, Central Banks may use specific market rates. These could be costs for manufacturers, consumer spending deflator, or various types of core indicators, derived by statistical instruments. There can be very different signals from the various indices. The government monitors inflation typically through the Central Bank. Monetary policy is the primary policy to reduce inflation. Additionally, stringent economic management, supply-side policies, wage regulation, exchange rate appreciation, and money-supply regulation can also be part of other strategies to mitigate inflation.
Through monetary policy, the Central Bank controls inflation by increasing rates of interest with the effect of decreasing consumer demand, contributing to decreased economic growth. Also, the Central Bank may control inflation by regulating the money supply in the economy. Moreover, supply-side policies aim to improve economic competitiveness, and productivity brings the long-term cost of downwards pressure. Fiscal policies, on the other side, control increment of product prices by increasing income taxes, thus reducing expenditure, demand, and inflation. In theory, attempting to control wages can reduce inflationary pressures.
Stable inflation expectations remove a significant source of macroeconomic uncertainty, namely the risk that a subsequent inflationary change will compound short-term economic shocks affecting inflation. Also, the stabilization of these expectations leads to economic growth by rising inflation credit quality in nominal bond yields, for instance. Thus, monetary policy can contribute significantly to macroeconomic stability by assuring price stability.
Oil is one of the world’s top revenue-making commodities. However, oil supplies worldwide are not equally distributed. The world has seen an inexorable rise since 2016, both concerning oil prices and the growing demand for petroleum. The petroleum industry has kept inflation and the supply and demand ratio at a consistently higher rate, which has caused the petroleum extraction rate to increase. The US Ministry of Energy accounts for more than 75% of global oil output and maintains nearly 93% of its reserves in just 15 countries, according to the United States released forecasts for 2015 (Vicondoa, 2019). These countries have a corresponding large percentage of the remaining unfunded petroleum resource in the world, estimated in untested sediment of similar geology by extrapolating established production and reserve results. Oil spending, in national budgets, is taken into account for the economies that are highly dependent on imports. Events such as instability in oil-producing countries, the discovery of new petroleum fields, and advances in petroleum-based technology have no surprise.
Inflation is influenced more strongly by rising oil prices. The level of consumer prices is 0.5% higher than the basic scenario for a five-year term. Any oil shock followed the global economy by a rise in costs. Oil price fluctuations contribute to a transition in supply and demand structure. Organization of the Petroleum Exporting Countries (OPEC) member states’ decreased oil production has helped increase oil prices. In the wake of the Iran-Iraq war and the capture of Kuwait, the price of oil has been adversely affected by Saudi Arabia’s production growth, which is marginally down in prices as the countries are one of those big oil producers (Damodaran, Thakkar & Aiyer, 2020). The situation hit Libya, one of the biggest oil-producing countries, and oil prices started to rise quickly following the military coup. The consumer price index (CPI) is the crucial indicator of inflation in most Central Banks. The increase in oil prices causes the GDP to decrease the rate of growth. Moreover, the rise in foreign prices has a negative impact on inflation, interest rates, and deficits on the budget. Logically, most influential countries rely on the exportation of oil. The short-term gains would be higher prices for exporting countries.
Research Problem
Considering the reactions and fluctuations of government spending to shifts in oil prices can advise lawmakers about the significance of stabilization funds. Also, it explains how well these funds can isolate expenditure from volatile income. The Great Depression of the 1930s influenced economic as well as political ideas profoundly. This event resulted in such a strong consensus that governments were trying to prevent events from occurring again. The effects of this event were so significant. Also, in this extreme scenario, however, there is a universal consensus that a stable economic environment makes a significant contribution to social and economic well-being (Temin, 2016).
Ever since the oil crisis in the 1970s, the track record of shocks in oil prices shows that oil prices are uncertain and unstable. In this way, future budget revenues are unknown. In contrast, an increasing oil price tendency appears to mitigate the monetary authority’s immediate stress on changing fiscal policies and decreases the need for economic management. Financial policies are associated with low-interest rates have also been voiced as concern that further growth in the kind of unsustainable private debt and asset prices, which contributed to the crisis in 2008, can lead. International energy markets have undergone substantial volatility over the last few years. Throughout the past decade, oil prices experienced a high degree of volatility, both as a significant input in the production cycle and as an excellent final consumption (Mian & Sufi, 2010).
Inflations result in high oil prices, tax revenue decreases, and Budget deficit increases, and interest rate increases. All these effects could lead to, at least in the short term, an increase in unemployment. The rise in oil prices also breaches trade and currency balance. Inflationary monetary and fiscal policies of oil-producing countries have not yet entirely been able to exacerbate recession and unemployment effects. Also, implementing monetary and fiscal expansion policies that are supposed to postpone a national revenue decline and, in the long run, exacerbate the effects of the oil prices have not been efficient. High oil prices have a more pronounced inflation effect (Summers, 2013).
Previous studies conducted on financial policies and their role in facing inflation include; (Anshasy and Bradley, 2012; Al-Qenaie, 2016; Shangle & Solaymani, 2020). However, none of these studies reviewed explicitly focused on financial policies and their role in facing inflation in oil-producing countries. Therefore, the study will be important in filling the research gap.
Significance of the Study
The research findings will be of great help to the researcher for it will help in understanding financial policies and their role in facing inflation in oil-producing countries. The finding will form a foundation for further research. Additionally, governments of oil-producing countries may use the finding from this study in formulating the appropriate policies to govern their countries. Moreover, various stakeholders in oil production and exportation will benefit from this study and will be able to make an appropriate decision on oil-producing countries.
Research Questions
The study will answer the following research questions;
- What is the role of monetary policy in facing inflation in oil-producing countries?
- What is the role of exchange rate appreciation policy in facing inflation in oil-producing countries?
- What is the role of money-supply regulation in facing inflation in oil-producing countries?
Literature Review
The section will focus on studies on financial policies and their role in facing inflation and how it relates to the current study on financial policies and their role in facing inflation in oil-producing countries. The study will focus on previous empirical studies on financial policies and their role in facing inflation. For instance, the study by Anshasy and Bradley (2012) explores the role of oil prices in the fiscal policy determination of petroleum exporting countries. The fiscal policy relates public expenditure not only to shocks in oil prices but also to oil price fluctuations and the slow changes in oil prices. They claim that higher oil prices contribute to higher government sizes in the long run. In the short run, government spending rises below the pace of increase in petroleum revenues, indicating increased prudence in oil-producing countries’ fiscal policies.
Additionally, Al-Qenaie (2016) did a study on inflation triggers in several countries that produce petroleum. The analysis provides panel data covering the duration from 1991 to 2014. Research indicates that the higher the price of oil, the lower the growth in income, the increase in the exchange rate, and the low population increase, all are related to high inflation. However, country-specific findings reveal that these countries have different inflation determinants. The results indicate that exchange rate fluctuations trigger the key inflation determinants for Algeria and Nigeria. In contrast, inflation factors for Iran are determined by exchange-rate differences, monetary, and demand-side factors. In Saudi Arabia, too, the causes of inflation come from side factors of supply and demand. Venezuela, on the other side, inflation comes from a variety of variables, including monetary and factors on supply and demand.
Moreover, research by Yoon et al. (2014) concerns the demographic effects in 30 OECD countries on macroeconomic variables. Population growth, as the research indicated, has a positive impact on inflation. Besides, they argue that population patterns and the interactions between the populations and macroeconomic variables can be diversified and impact inflation differently according to the stage in the demographic transition. Such include lower total demand and a negative impact on the asset prices, and in relative price changes that reflect different consumer preferences.
Furthermore, Shangle and Solaymani (2020) analyzed monetary policies’ responses to Malaysia’s rising oil prices. The study simulates monetary policies with a financial computable general equilibrium (CGE) model to respond to the global price changes in Malaysia. It takes into account all shifts in global oil prices (an increase and a decrease). The simulation results showed that overall Malaysia, even most enterprises benefit from an increase in oil prices and losing from a decline in oil prices. Both shocks cause resource reallocation and affect the economic, financial component. The results as well show that tightened financial policies do not reduce the adverse effects of both economic and industrial growth. Expansion policy is fruitful and beneficial to Malaysia’s economic growth and industrial production, especially the combined reduction of the reserve ratio and interest rate.
Marashdeh (2017) examined whether the shifts in oil prices are capable of predicting stock market returns for the world’s three major oil-producing nations, namely, Russia, Saudi Arabia, and the United States of America, using various models for 2000:01-2015:05 to correct vector errors. The critical theory is that changes in the price of oil rely not only on either supply or demand side of oil shocks but also on if the nation researched is import oil or exports. The findings concluded that, in particular, oil prices shift induced by supply shocks have positive repercussions on Russian stock market returns, reduced impacts on the United States, and uncertain repercussions on Saudi Arabia. Notably, oil price change is influenced by the demand that affects all the three countries positively.
Chavula, Tefera, Kedir, and Awel (2017) assessed Monetary and Other Financial Policies for Africa’s Structural Transformation. The analysis needs some valuable policy insight to execute exchange-rate policies properly, taking into account possible trade-offs between inflation and the exchange rate based on national characteristics. The study emphasizes the need for cautionary access by African countries to non-concessional debt that can result in unsustainable debt rates. The review highlighted that Africa’s growth and development are hampered by the absence of deeper and productive financial markets. Overall, the independence of the Central Bank, effective inflationary pressures management, and enhanced policy coordination between the monetary and fiscal policies will lead to the improvement and economic restructuring of macroeconomic policies in the continent.
Lopes, Fuinhas, and Marques (2017) established the relationship between Energy and Carbon (II) Oxide: the effect of financial deep on oil-producing countries. The study postulated that Brazil is at the technological forefront of using biofuels in the sense of low carbon economy and growing demand for sustainable and renewable sources of energy. The sugar energy sector plays a major role in the agri-business in Brazil, but its financial condition has deteriorated significantly. A methodology for estimating costs for sugar and ethanol production in Brazil is provided in this article. The paper focused on technical and economic studies for the manufacturers of mills and sugarcane, in addition to growth. In the context of the low carbon economy and the growing need for clean and renewable energy, Brazil is the technical and productivity pioneer in biofuels. The study provides a framework for estimating costs for the production of sugar and ethanol in Brazil.
In summary, from the literature reviewed, it is evident that financial policies play a role in facing inflation. The empirical studies reviewed include; Anshasy and Bradley (2012), who did a study on oil prices and the fiscal policy response in oil-exporting countries. Also, Al-Qenaie (2016) did a study on the causes of inflation across main oil-exporting countries. Moreover, Shangle and Solaymani (2020) assessed the responses of financial policies to changes in oil prices in Malaysia. Marashdeh (2017) examined whether the shifts in oil prices are capable of predicting stock market returns for the world’s three major oil-producing nations, namely; Russia, Saudi Arabia, and the United States of America. Chavula, Tefera, Kedir, and Awel (2017) assessed Monetary and Other Financial Policies for Africa’s Structural Transformation. Lopes, Fuinhas, and Marques (2017) established the relationship between Energy and Carbon (II) Oxide: the effect of financial deep on oil-producing countries. However, none of these studies reviewed explicitly focused on financial policies and their role in facing inflation in oil-producing countries. Therefore, the study will be important in filling the research gap.
Methodology and Plan
A descriptive research design will be applied in this research. Notably, this research design is deemed appropriate because there are no manipulated variables involved, and the current state of the phenomenon is defined. The target population under study comprises sixteen oil-producing countries: Algeria, Mexico Bahrain, Colombia, Egypt, Iran, Nigeria Kuwait, Malaysia, Mexico, Norway, Oman, Cameroon Syria, UAE, Indonesia, and Venezuela.
The study will use secondary data mined from the sixteen countries’ financial reports for a period of the last 10years (2009-2019). The collected data will be edited and rectified for errors or omissions that may affect the accuracy of the research. In this study, quantitative data will be analyzed by descriptive statistics using the Social Science Statistical Package ( SPSS) version 26.0. This analysis will use both descriptive and inferential analysis.
References
Al-Qenaie, J. (2016). Causes of inflation across main oil-exporting countries. SciencesPo, Kuwait.
Chavula, H. K., Tefera, M. G., Kedir, A. M., & Awel, Y. M. (2017). Monetary and Other Financial Policies for Africa’s Structural Transformation. In Macroeconomic Policy Framework for Africa’s Structural Transformation (pp. 145-216). Palgrave Macmillan, Cham.
Damodaran, A., Thakkar, S., & Aiyer, N. (2020). Syriana Once Again: Speculations on the Future of OPEC. IIM Bangalore Research Paper, (606).
El Anshasy, A. A., & Bradley, M. D. (2012). Oil prices and the fiscal policy response in oil-exporting countries. Journal of Policy Modeling, 34(5), 605-620.
Lopes, M. A., Fuinhas, J. A., & Marques, A. C. (2017). On the Relationship of Energy and CO2: The Effect of Financial Deep on Oil Producing Countries. China-USA Business Review, 108.
Marashdeh, H. (2017). Oil price shocks and stock market returns in the three largest oil-producing countries.
Shangle, A. & Solaymani, S. (2020). Responses of monetary policies to oil price changes in Malaysia. Energy, 117553.
Temin, P. (2016). Great Depression. In Banking Crises (pp. 144-153). Palgrave Macmillan, London.
Vicondoa, A. (2019). Monetary news in the United States and business cycles in emerging economies. Journal of International Economics, 117, 79-90.
Yoon, M. J. W., Kim, M. J., & Lee, J. (2014). Impact of demographic changes on inflation and the macroeconomy (No. 14-210). International Monetary Fund