The Impact of Inflation on Private Consumption Expenditure (1980-2023)

Yip, J-Kei (2026) The Impact of Inflation on Private Consumption Expenditure (1980-2023). Final Year Project (Bachelor), Tunku Abdul Rahman University of Management and Technology.

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Abstract

This study investigates the impact of inflation on private consumption expenditure in Malaysia, using annual time series data spanning 1980 to 2023. The main objective is to analyse the relationship between key macroeconomic indicators where Consumer Price Index (CPI), interest rates, and Gross Domestic Product (GDP) and their effects on household expenditure. Drawing on secondary data from the World Bank and Malaysia’s Official Open Data Portal, the research provides a comprehensive 39-year analysis, offering historical insights into how inflation interacts with private consumption in the Malaysian economy. The study examines the existence of long-run equilibrium relationships, estimates short-run adjustments and long-run elasticities, and derives policy implications for managing inflation’s effects on household expenditure. Econometric methods were employed, the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests confirmed that all variables are integrated of order one, I(1). The Johansen-Juselius cointegration test identified a stable long-run relationship, and the Vector Error Correction Model (VECM) was used to capture both short-run dynamics and long-run equilibrium. The empirical findings reveal that inflation, proxied by CPI, has a negative and statistically significant effect on private consumption. Specifically, a 1% increase in CPI reduces private consumption expenditure in the long run. By contrast, GDP demonstrates a positive effect, where a 1% increase in GDP leads to higher private consumption, highlighting the importance of income growth in sustaining demand. Interest rates show a negative long-run impact, with a 1% increase reducing private consumption, while short-run effects were weaker and statistically insignificant. These findings highlight the dual challenge for policymakers where controlling inflation to safeguard household purchasing power while simultaneously promoting income growth to sustain long-term spending. They also underscore the sensitivity of private consumption to interest rate changes, reinforcing the need for carefully calibrated monetary policy to avoid unintended suppression of domestic demand. This study provides strong evidence that inflation exerts a contractionary effect on private consumption expenditure in Malaysia, while GDP growth stimulates spending and interest rates dampen it in the long run. These results enhance the empirical literature on emerging economies and offer valuable policy insights for managing inflationary pressures while safeguarding household welfare.