Discuss the likely causes of inflation in Singapore. [15]

Discuss the likely causes of inflation in Singapore. [15]

Inflation occurs when there is a rise in the general price level of goods and services. Inflation becomes a problem when the rise in general price level is sustained and inordinate. With inflation, a given amount of nominal income buys less goods and services than before. Inflation caused by demand-side factors is known as Demand-pull inflation while inflation caused by supply-side factors is known as Cost-push inflation.

Firstly, demand-pull inflation occurs when Aggregate Demand (AD) rises as the economy approaches full employment. AD will rise if there is a decrease in interest rate as when there is a decrease in interest rate, it becomes cheaper and easier for people to consume and invest causing consumption and investment to increase.

Secondly, AD will also rise when there is a decrease in personal income tax as people will tend to have more disposable income and this increases their purchasing power and will cause consumption to increase. Since AD comprises C + I + G + (X-M), which are consumer spending, investment spending, government spending, and net exports, a rise in consumption and investment spending will cause AD to rise from AD to AD2.

Lastly, Factors like increase in government spending and net exports and will also cause AD to rise, leading to demand-pull inflation as general price level increases from P1 to P2.

Cost-push inflation occurs when Aggregate Supply (AS) rises due to economy-wide rises in production costs, for reasons not associated with rising domestic demand. As labour cost is often the largest component of total cost, a sudden rise in wages can cause significant cost-push inflation. Rising food, fuel, property prices, exchange rates and the foreign sector are also factors that causes AS to rise from SRAS1 to SRAS2, (Figure 2) leading to cost-push inflation as general price level increases from P1 to P2. Imported inflation can lead also lead to cost push inflation.

Singapore is a small country with very limited land resources and no natural resource, hence she has to heavily depend on imports from other countries for both consumption goods and factor inputs. Hence, the biggest threat to inflation in Singapore would be the depreciation of the Singapore Dollar. If the Singapore dollar depreciates too quickly, it causes severe imported inflation which impacts households directly through rising good and energy prices. Imported inputs also become more costly, thus raising production costs and product prices.

With a small domestic market and being highly export-oriented, Singapore is more dependent on external rather than domestic demand. If the Singapore dollar were to appreciate too quickly, her exports and hence AD would plummet and this potentially triggers a recession.

Hence, Singapore’s central bank, known as the Monetary Authority of Singapore (MAS) has a primary objective which is to promote price stability through monetary policy. In order to effectively manage Singapore’s exchange rate, the central bank buys back its own currency from the foreign exchange market which reduces money supply to raise the exchange rate. Conversely, the central bank also sells domestic currency on the foreign exchange market which raises money supply to lower the exchange rate.

J