The new theory that exists in this research is to investigate the relationship between the expected inflation towards the real inflation rate.
Expected inflation can be known as a vague figure as it is public’s expectation of the inflation which can’t be measured accurately. There is positive relationship between expected oil price and inflation rate. When crude oil price is expected to increase in the future, oil which acts as the main input in food production will thus increase the food price in future, therefore consumers need to increase their amount of money in purchasing which then increase inflation rate. Besides, expected food price has positive correlation with inflation rate. When consumer expected that food price will increase in future, they will start to demand more income which then increases wage rate and thus increase inflation rate.
Last but not least, the relationship between expected inflation rate and wage rate is positive. When consumers expected that inflation rate will increase in the future they will, therefore, demand more of the wage rate so as to afford the increasing cost of living.Since modern agriculture depends heavily on oil products in every stage of food production and marketing, therefore, oil acts as an input in agricultural chemicals which means that high and unstable prices of global crude oil will cause food price to increase (Bloomberg, 2011). Arshad and Hameed (2009) had conducted unit root, co-integration, and Granger causality tests to test the relationship between crude oil and maize, rice and wheat. It shows that changes in the price of crude oil play an important role in changing of the major cereal prices.
The results showed that there is a unidirectional long-run relationship between crude oil price and cereal price. Yu et al. (2006) interpreted that the causality of higher crude oil price on the price of vegetable oils. They concluded that the influence of hike in crude oil price on the variation of vegetable oil price is relatively small. Besides, Fabiosa (2009) concluded that the correlation structure between crude oil price and grain price increased dramatically and their relationship becomes more significant.
According to Ibrahim (2015) and Abdlaziz, et al. (2016), by using nonlinear Autoregression Distributed Lag (NADRL) model to study the effect of oil price changes on food price inflation in Malaysia. Throughout the research, there is a significant relationship between oil price increases and the food price increases in long run relationship. However, the relationship between reduction in oil price and food price is not significant either in long-run or short-run relationship.