(2015) A Level H2 Econs Paper 2 Essay Q4

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4. In its September 2013 Recent Economic Developments Statement, the Monetary Authority of Singapore noted that inflation was expected to rise moderately. Strong GDP growth in Q2 2013 was mainly due to increased output in the manufacturing and trade-related service sectors with a slowing growth in private consumption. There was expected to be continued strong wage pressure from persistent tightness in the labour market caused by shortages in labour supply accompanied by steady expansion in demand for goods and services from the US, Japan and the Eurozone.
Source: Recent Economic Developments in Singapore, MAS, 5 Sep 2013

(a) Explain how the above-mentioned factors might have caused the rate of inflation to rise in Singapore. [10]

Introduction

The above mentioned factors cited are mainly

1. Increased output in the manufacturing and trade-related service sectors with a slowdown in growth in private consumption

2. Strong wage growth from persistent tightness in labour market

3. Steady expansion in demand for goods and services from the US, Japan and the Eurozone

Highlight that in Singapore, there are usually multiple causes of inflation which includes demand pull, cost push and also imported inflation. (explain)

Demand-pull inflation

• The increased output in manufacturing & trade related service sectors would have indicated an increase in Investment spending (increase in production capabilities), whilst there are also indications of an increase in private Consumption (albeit there was a slowdown).

• Steady expansion in demand from US, Japan & the Eurozone suggests that Net Exports (X-M) would have likely been increasing.

• An increase in C, I, G & (X-M) would have led to a relatively significant increase in AD -> given that Singapore is operating at near full employment level -> increase in GPL -> demand pull inflation

Cost-push inflation

The persistent tight labour market contributing to strong wage growth without any evidence of any corresponding rise in productivity could have contributed to an increase in labour costs. An increase in labour costs -> increase in cost of production -> leftward shift in SRAS -> increase in general price level -> cost push inflation

(b) Discuss whether exchange rate appreciation should remain the most important policy instrument in controlling the rate of inflation in the Singapore economy. [15]

Introduction

• Inflation refers to a sustained increase in GPL within an economy.

• Singapore aims for low and stable inflation of around 2% per year and uses various policies to achieve price stability.

HOW EXCHANGE RATE POLICY MAINTAINS PRICE STABILITY IN SINGAPORE

SG’s managed float exchange rate regime

• Basket: SG’s currency is managed against a basket of currencies of our major trading partners

• Band: SG’s currency is kept within a stipulated band whereby free market forces are allowed to determine the value of the SGD as long as it stays within the bands. This allows for some flexibility and yet ensures stability. If the SGD falls outside the band, MAS will intervene by buying and selling SGD on the foreign exchange market to bring it back to within the bands

• Crawl: The slope, width and level of bands are adjusted periodically based on economic fundamentals

• (RWA)  In Singapore, we generally encourage a ‘modest and gradual’ appreciation stance of the SGD. Such a stance helps to address the issue price stability by reigning in all 3 types of inflation:

  1. Demand pull inflation is reduced – exports become more expensive, while imports become cheaper with a stronger SGD, reducing (X – M) reduces AD

  2. Imported inflation is reduced – imports become cheaper with a stronger SGD

  3. Cost-push inflation is reduced – since imported inputs are cheaper

Why other policies should be considered to control the rate of inflation in Singapore?

A key cause of inflation is due to rising labour costs

• Strong wage growth leading to increase in labour costs is something that the appreciation of the exchange rate cannot help resolve.

• For this, we should consider the use of supply side policies to increase productivity, for example

1.       Increasing spending on education

2.       Provide subsidies for firms to send workers for training

3.       Increase spending on measures for technology adoption and automation

•  Such above-mentioned policies could help to mitigate the increase in labour costs by reducing the cost of production in other ways.

 

Imported inflation is not a significant cause of inflation

While imported inflation is usually a key source of inflation in Singapore, this is not a significant point mentioned

 

Exchange rate policy remains an important policy

Given that there is presence of demand pull inflation caused by strong export-led demand, an appreciation of the SGD can help to moderate this specific cause of inflation and therefore is still a relevant policy.

Note: Generally exchange rate policy still remains relevant, as it is a flexible tool that we can change

Other issues causing inflation in SG (contextual knowledge)

• While exchange rate policy is important in maintaining price stability, we need to recognise that trade related issues are not always the only causes of high inflation in our economy, there are both other domestic and external issues leading to higher prices in the economy. E.g. in recent years, overheated property market (due to inflows of hot money and low interest rate environment) and car market (due to limited COE supply and higher incomes)

• Macroprudential policies such as cooling measures through implementations of various loan restrictions and stamp duties to curb demand for properties / cars.

Conclusion

Given that inflation in Singapore is multi-faceted, an exchange rate policy cannot be the only policy implemented. A mix of policies should be implemented to complement each other and achieve price stability in Singapore.

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