(2016) A Level H2 Econs Paper 2 Essay Q6

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6. Between 2012 and 2013, the number of Singapore dollars required to buy US dollars and Chinese Renminbi increased by 3.5% and 6.6% respectively, while the number of Singapore dollars required to buy Japanese Yen and Malaysian Ringgit fell by 15.2% and 3.5% respectively.
Source: Monetary Authority of Singapore

(a) Explain how an appreciation of a country’s currency might affect the current account of its balance of payments. [10]

How an appreciation may affect the current account

1. An appreciation of a country’s currency will make the currency stronger in relative terms compared to foreign currencies

2. The country’s exports will become more expensive to foreigners → fall in demand for exports → fall in (X-M) → worsening of current account

3. Imports will become relatively cheaper for locals → rise in demand for imports → fall in (X-M) → worsening of current account

4. If a country is a key exporter of goods that are largely price inelastic (e.g. oil & commodities) → an appreciation causing Px to be more expensive for foreigners will result in a less than proportionate fall in quantity demanded → total export revenue may increase instead of decreasing → improves current account

5. If a country imports most of its inputs (e.g. Singapore) → appreciation will result in imported inputs becoming cheaper → lower cost of production for goods & services → reducing Px → which can mitigate the impact of higher export prices caused by an appreciation → reduced impact in terms of current account worsening

How an appreciation may affect the capital & financial account

1. An appreciation of a country’s currency if it happens over a prolonged period of time, can signal a healthy and growing economy

2. This can result in increased confidence in the economy by investors → increasing inflows of FDI in the capital account

(b) Discuss how the likely overall effects of the changes in the exchange rate in 2012-13 on Singapore’s domestic economy. [15]

Introduction

1. Since it costs more SGD to purchase USD and RMB, the Singapore dollar depreciated against the USD & RMB

2. Since it cost less SGD to purchase MYR & JPY, the Singapore dollar appreciated against the MYR & JPY

Impacts of a depreciation on the economy

1. A depreciation of the SGD can result in exports to US / China becoming cheaper in foreign currency → increase demand for Singapore’s exports (X-M) → increase in AD → increase in real NY → higher economic growth

2. As firms hire more factor inputs such as labour → fall in cyclical unemployment

3. An increase in (X-M) can also improve the current account balance

4. As the same time, Singapore purchases imported inputs from countries like China, a depreciation of the SGD against the RMB may cause cost of production to go up as imported inputs become more expensive → increasing export prices

5. This can mitigate any advantage from the depreciation of the SGD on export prices

6. A depreciation can also caused imported goods from US & China to become more expensive → causing imported inflation (as Singapore imports many of its necessities)

Impacts of an appreciation on the economy

1. An appreciation of the SGD can result in imports from Japan / Malaysia becoming cheaper to locals → increase in demand for imports (M) → fall in (X-M)

2. An appreciation of the SGD can result in exports becoming more expensive to foreigners → increase in demand for imports (M) → fall in (X-M)

3. Fall in (X-M) → fall in AD → fall in real NY via k → lower economic growth

4. As firms hire less factor inputs such as labour → rise in cyclical unemployment

5. Fall in (X-M) → worsening of the current account balance

6. As the same time, Singapore purchases imported inputs from countries like Malaysia, an appreciation of the SGD against the MYR may cause cost of production to go down as imported inputs become less expensive → decreasing export prices

7. This can mitigate some disadvantages from the appreciation of the SGD on export prices

8. An appreciation can also caused imported goods from Malaysia & Japan to become cheaper → reducing imported inflation (as Singapore imports many of its necessities)

Reconciling what will likely be the overall effects

1. The overall impact will likely depend on whether Singapore exports more to these countries than it imports from these countries

2. As Singapore imports most of its inputs, an appreciation of the SGD would likely be more advantageous than a depreciation of the SGD

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