(2013) A Level H2 Econs Paper 2 Essay Q5

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5. On 1 September 2011 the Monetary Authority of Singapore (MAS) reported that inflationary pressures remained strong because of the tight domestic labour market, high consumer spending and rising global commodity prices.

(a) Explain how the factors mentioned above will lead to inflationary pressures remaining strong in Singapore. [10]

Tight labour market coupled with high consumer spending

1. A tight labour market implies that the economy is already operating at full or near full employment level

2. Assuming that high consumer spending implies an increase in Consumption spending (higher than in previous periods) →  a rightward shift in AD given that economy is already operating at full or near full employment level as seen in Figure 1, will cause an increase in general price level from P0 to P1

3. A tight labour market can also mean that wage rates would be rising as it becomes more difficult to employ workers and firms adjust wages upwards to compete for workers.

4. This can shift SRAS to the left as seen in Figure 2 from AS0 to AS1, causing general price level to increase from P0 to P1

Rising global commodity prices

1. Commodities refer to goods such as oil, natural gas, gold, silver, wheat, corn

2. Rising global commodity prices will usually cause goods such as food to become more expensive as cost of factor inputs (such as oil, wheat & corn which can be used in the production of many agricultural goods) in the worldwide production of food increases

3. Singapore imports many of its necessities especially food, rising global commodity prices will likely mean Singapore will import such price increases, resulting in imported inflation

4. Rising commodity prices will also mean an increase in prices of many imported inputs which will cause an increase in cost of production for local firms

5. This can shift SRAS to the left as seen in Figure 2 from AS0 to AS1, causing general price level to increase from P0 to P1

(b) Discuss alternative economic policies that the Singapore government might consider adopting to alleviate these inflationary pressures. [15]

Tightening monetary policy

1. Singapore uses exchange rates instead of interest rates as a monetary policy instrument and manages Singapore’s exchange rates via the ‘BBC’ principle

• Basket - the SGD is managed against a basket of currencies which include major world currencies and currencies of our trading partners (e.g. USD, Euro, MYR, RMB)

• Band - the SGD is allowed to float freely within undisclosed bands, and if the SGD appreciates or depreciates beyond the limits, MAS will intervene through buying of selling of foreign currencies in order to bring the SGD back to within the bands

• Crawl - the policy band is typically set to crawl, with reviews being done twice annually

2. Typically, MAS adopts a ‘modest and gradual appreciation’ stance where the SGD is allowed to progressively appreciate

3. A stronger SGD will make it cheaper for locals to buy imported goods → fall in import prices → fall in imported inflation

4. As imported inputs become cheaper → it reduces cost of production → rightward shift of SRAS → fall in general price levels

5. A stronger SGD makes exports more expensive → reduces (X-M) → fall in AD → fall in GPL from P0 to P1 → fall in demand pull inflation

Tradeoffs: A stronger makes exports less competitive → fall in (X-M) → fall in AD → fall in real NY → lower economic growth (and higher unemployment)

Limitations: A slight appreciation in the currency may not be able to significantly offset import prices if there are significant increase in import prices (like in the case of higher prices caused by supply chain disruptions / Russo-Ukrainian war in 2022)

Supply side policy: Diversification of import sources

1. As Singapore depends on importing many of its inputs and necessities, an increase in price of any inputs / necessities in source countries can contribute to imported / cost-push inflation

2. The government can work towards diversifying import sources through importing inputs and necessities via a wide range of countries so that the country is not dependent on just one or a few countries

3. This will prevent the case where a sharp rise in price of a commodity from a single import source resulting in sharp rise in price in Singapore

Limitations: Higher transportation costs may result from importing from countries further away geographically.

Supply side policy: Increase productivity

1. The government can encourage an increase in productivity by subsidising firms’ efforts to carry out research & development on process innovation or subsidising workers’ retraining & upgrading efforts

2. An increase in productivity will result in a lower cost of production, thus mitigating any price increases caused by an increase in prices of imported inputs

Evaluation

Such policies take a long time to implement / see results, while price increases caused by higher commodity prices are likely sudden and impacts to prices are immediate.

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