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MACROECONOMIC OBJECTIVES IN SINGAPORE

Low Inflation
Introduction
Inflation refers to a situation where there is a sustained, inordinate increase
in general price. The inflation rate is measured as the percentage change in
the consumer price index over a period of time.

Low inflation
Low inflation is important because it provides a conducive environment for
savings and investment.
Low inflation ensures a stable value of money. Hence the real value of
savings is protected. When inflation is low, nominal interest rates will fully
compensate for the rise in general price level, which then allows any given
amount of savings to buy the same amount of goods and services. However,
if inflation is high, the real value of savings is reduced.
For investors, low inflation means that they can more easily project future
returns on their investments .Since low inflation tends to be more stable, this
allows firms to find greater ease in estimating the costs and revenues of
investment when inflation is low. Hence they are more willing to undertake
risks of investments.
Low inflation helps to improve export competitiveness. When inflation is low,
domestic goods and services may become relatively cheaper than foreign
goods and services. It also ensures that the countrys exports are pricecompetitive. Hence this increases the quantity demanded of the countrys
exports and its export earnings, thereby improving its current balance.
It also protects the purchasing power of wage earners and thus the standard
of living of the people. Low inflation also ensures stable value of the
countrys currency. A strong Singapore dollar is important for Singapore. It
instils foreign investor confidence in the economy because it reflects
economic growth and good governance. Since Singapore depends on foreign
investment, the strong Singapore dollar enhances its ability to attract foreign
investment.

Demand-Pull Inflation
Demand-pull inflation is caused by an increase in aggregate demand which
can be contributed by an increase in consumption, investment, government
expenditure, export or a decrease in import, and it occurs when aggregate
demand persistently exceeds aggregate supply when the economy is near or

MACROECONOMIC OBJECTIVES IN SINGAPORE

at full employment level. There will be higher competition of factors of


production, which would have already been employed to produce goods and
services. The higher competition of factors of production, which would have
already been employed to produce goods and services. The higher
competition for the factors of production drives up the prices of these factors
and lead to an increase in the cost of production, which can be translated to
a higher general price level, as producers pass on the increase in cost to
consumers.

Cost-push inflation
Imported cost-push inflation arises when a country imports from countries
that experience inflation. The prices of these imports will rise. If these
imports are intermediate goods, it will push up the unit cost of production
and final price. Imported consumer goods become more expensive,
contributing to the overall increase in the general price level. Singapore is a
small, open economy that is heavily dependent on foreign imports such as
oil. When there is an increase in the price of oil, it increases the unit cost of
production in Singapore. As the cost of production becomes higher,
producers cut back in production, resulting in a lower national output from Y0
to Y1, and the general price level increases from P0 to P1, resulting in
imported cost-push inflation.
Wage-price spiral occurs when powerful union demand for higher wages not
due to any change in demand for labour. As employers give in to their
demand for higher wages, and assuming that the wage increase is not
matched by a corresponding increase in labour productivity, this leads to
higher unit costs of production, which in turn leads to higher prices and
inflationary pressures. The higher prices can in turn lead to trade unions
demanding still higher wages and which then causes the firm to raise their
prices again to maintain the profit margin, thereby triggering a wage-price
spiral as the cycle continues.
However, this is not such a prevalent problem in Singapore because
Singapores labour unions are highly regulated and supported by the
government, as the government is in a tripartite relationship with the unions
and firms in solving labour disputes. Hence firms in Singapore do not give in
demands of employees without a third-party mediator such as the Workforce
Development Agency.

Impact of High Inflation on the Balance of Payment


of Singapore

MACROECONOMIC OBJECTIVES IN SINGAPORE

High imported cost-push inflation makes intermediate goods more


expensive, which then increases the cost of production in Singapore, leading
to exports being less price-competitive due to increases in price caused by
the increase in the cost of production. Given that Singapores export demand
tends to be price-elastic with the availability of close substitutes, an increase
in price can lead to a more-than-proportionate fall in the quantity demanded.
Hence Singapores export revenue is likely to fall. Furthermore, Singapore is
very dependent on imported goods due to its lack of natural resources. Since
the demand for imports tend to be price-inelastic, Singapores import
expenditure is likely to increase. The fall in export revenue and the increase
in import expenditure in Singapore combines to worsen Singapores trade
balance under the current account, which translates to a worsening of the
balance of payment.
However, if Singapore manages to improve its export competitiveness at the
same time through research and development in coming up with more costeffective methods of production and better quality of goods and services
produced, the extent of the worsening of balance of payment may not be
significant.

Suggested Policies
Exchange-rate Policy (Appreciation)
Singapore operates under the managed float exchange rate system due to
the small and open nature of its economy. As a small and open economy, its
exports and imports are relative to its national income. Therefore, the
Monetary Authority of Singapore (MAS) holds the view that exchange rate is
the most effective policy instrument for achieving low inflation in Singapore.
Furthermore, due to Singapores large trade connections with the world, the
MAS manages the exchange rate of the Singapore dollar against a tradeweighted basket of currencies of Singapores major trading partners within
an undisclosed band. Exchange-rate policies can be used to reduce inflation
in Singapore. An exchange rate policy is one that is used to control the
exchange rate to influence aggregate demand or aggregate supply.
Whenever the MAS predicts a strong external economic environment it raises
the policy band gradually and modestly to allow the gradual and modest
appreciation of the Singapore dollar as a pre-emptive measure against
potential inflation. When the Singapore Dollar (SGD) becomes stronger, the
rise in the price of imports in Singapore becomes lower, which then reduces
imported inflation. The stronger SGD also leads to a small increase in
ext3ernal demand for Singapores exports and this helps to lower demandpull inflation in Singapore as well.

MACROECONOMIC OBJECTIVES IN SINGAPORE

Expansionary fiscal policy


Fiscal policy I a demand-side policy that is used to control government
expenditure or taxation to influence aggregate demand. In this case, fiscal
policies can be used for their supply-side effects to achieve a rise in
aggregate supply. This occurs when the government increases expenditure
on goods such as education, training, research and development or
decreases corporate tax and income tax. Assuming that the aggregate
demand in Singapore is rising, which is the trend in Singapore, a more rapid
increase in aggregate supply can lead to a smaller rise in the general price
level and hence lowers inflation.
However, the supply-side effect of fiscal policies is realised only in the long
run. The demand-side effect is higher inflation in the short run. Furthermore,
a continual increase in government expenditure may also lead to a persistent
budget deficit, resulting in adverse consequences for the economy.

Supply-Side policies
Supply-side policies are policies that are used to increase the production
capacity in the economy and hence the aggregate supply. In addition to
government expenditure on education, training, research and development,
supply-side policies such as immigration policies and foreign-worker policies
can be used to achieve a more rapid increase in aggregate supply and hence
lower inflation in Singapore. Furthermore, Singapores government can
reduce employers CPF contribution to reduce the labour cost in Singapore.
This was actually seen when the government implemented the workfare
supplement scheme to encourage firms to increase the wages of their
workers and the government actually helped sponsor a percentage of the
pay rise. OCBC Bank in 2014 has used the money given by the Singapore
government to give back to their staff as bonuses for their good work instead
of helping themselves to lower cost. This shows that a firm can make various
choices as to how to spend the money given to them by the government.
The overall intention for the government is to help firms to cut cost and
increase the wages of workers at the same time. When the cost of production
in Singapore falls, the aggregate supply rises, which leads to lower inflation.
However, the effect of supply-side policies are only realised only in the long
run. Furthermore, if reducing employers CPF contribution leads to firms
increasing in profits then the distribution of income becomes less equitable.

Free trade agreements


The Singapores government can sign more FTAs to reduce inflation in
Singapore. If Singapore signs more FTAs, we will be able to select cheaper

MACROECONOMIC OBJECTIVES IN SINGAPORE

import options, as there will be a large range of goods and services to choose
from. Hence the cost of production will fall and this will lead to a rise in
aggregate supply and thus lower inflation. Furthermore, if Singapore signs
more FTAs, its investment expenditure will rise, which will lead to a more
rapid increase in aggregate supply and hence lower inflation in the long run.
However, in the short run signing more FTAs can lead to higher inflation. In
addition, signing FTAs is a long-term policy and requires time for negotiation
before the agreements can be signed.