Assess whether the policies designed to achieve price stability would inevitably result in trade-offs for Singapore's economy.
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(b) Assess whether the policies designed to achieve price stability would inevitably result in trade-offs for Singapore's economy. [15]
TJC 2024
Modest and gradual appreciation of the exchange rate
One key policy used by Singapore’s Monetary Authority (MAS) to maintain price stability is a managed float exchange rate regime, with a strategy of modest and gradual appreciation of the Singapore Dollar (SGD). By allowing the SGD to appreciate, inflationary pressures can be curbed in several ways:
A stronger SGD makes Singapore’s exports more expensive for foreign consumers, reducing demand for these goods. This reduction in exports (X) lowers the (X-M) component of Aggregate Demand (AD), which leads to a leftward shift in AD from AD0 to AD1. The contraction in AD leads to a reduction in general price levels from P0 to P1, easing demand-pull inflation. However, this also means that as demand for Singapore's exports falls, real national income will decline from Y0 to Y1, potentially resulting in lower economic growth.
The appreciation of the SGD also lowers the cost of imports, as foreign goods become relatively cheaper. This includes essential imported items like food, energy, and raw materials. Cheaper imports reduce the cost of goods within the Consumer Price Index (CPI), leading to lower imported inflation. Additionally, lower costs of raw materials and oil reduce the costs of production, which shifts the Short-Run Aggregate Supply (SRAS) curve to the right, from AS0 to AS1, resulting in lower price levels from P0 to P1.
While these benefits help control inflation, trade-offs emerge, particularly in terms of economic growth and employment. As export demand falls, firms will scale back production, leading to lower real national income. The reverse multiplier effect further exacerbates this reduction, as lower production leads to reduced demand for labour and other inputs, potentially raising unemployment. The balance of trade may also worsen, especially if import growth outpaces export demand, which could lead to a worsening current account balance. These trade-offs explain why Singapore adopts a gradual appreciation to avoid severe negative impacts on growth and employment.
Supply side policies
To complement its exchange rate policy, Singapore has also implemented supply-side measures aimed at improving productivity and enhancing the long-term growth potential of the economy. Notably, the Foreign Worker Levy (FWL) and Dependency Ratio Ceiling (DRC) policies have been used to reduce Singapore’s reliance on foreign labour and encourage firms to increase productivity. These policies aim to shift the focus towards a productivity-driven economy rather than one dependent on cheap foreign labour.
By increasing the costs of employing foreign workers through higher FWL and stricter DRC limits, firms are pushed to invest in technology and upskill their local workforce to maintain competitiveness. Over time, these productivity improvements should lead to an outward shift in the Long-Run Aggregate Supply (LRAS) curve, increasing potential output and enhancing long-term economic growth.
In the short term, however, these policies may lead to higher production costs. As firms face increased labour costs, they may pass these costs onto consumers in the form of higher prices, resulting in cost-push inflation. This is depicted by a leftward shift in the SRAS curve from AS0 to AS1, increasing the general price level from P0 to P1. This inflationary pressure could be significant, particularly in industries that rely heavily on foreign labour, such as construction and services.
In the short term, firms may find it difficult to replace foreign workers with local labour or technology, especially if the productivity gains from these investments take time to materialise. This could lead to reduced output, higher unemployment, and slower growth. The higher cost of labour could also make some firms less competitive globally, further affecting export performance.
Conclusion
While policies designed to achieve price stability, such as exchange rate appreciation and supply-side measures, are effective in controlling inflation, they inevitably come with trade-offs for Singapore’s economy. Exchange rate appreciation may reduce inflation but at the cost of slower export growth, reduced national income, and higher unemployment. Supply-side policies, while beneficial in the long run through increased productivity, could lead to short-term inflation and reduced output as firms adjust to higher labour costs.
Note to students: Other supply side policies, as well as contractionary fiscal policy can be considered as alternative policies for the discussion.