Discuss the relative significance of interest rates, exchange rates and tax rates as instruments for economic policy in Singapore.

Introduction

  • The unique characteristics of Singapore’s economy has helped to shape the instruments that the government has at its disposal to achieve the various economic objectives in the economy.
  • Due to its ‘smallness’, Singapore has adopted an “open” economy approach to drive its development.

Body

Interest rates

  • Due to Singapore’s size, we are a price taker in the world market for funds. Singapore’s interest rates are influenced heavily by the interest rates of other larger economies and expectations of how the Singapore dollar will change.
  • At the same time, due to Singapore’s small domestic size, we are reliant on exports as an engine of growth and hence there is a need to manage our exchange rates to ensure export competitiveness.
  • Singapore’s reliance on imports due to our resource scarce situation also underscores our need to manage our exchange rates to ensure that we are able to import basic necessities as well as raw materials that are necessary for production of exports at prices that will not result in Singaporeans facing excessively high general price levels or that will result in our exports losing competitiveness.
  • Given that interest rates in Singapore are largely determined by the rest of the world as well as the importance of capital mobility and exchange rate stability, interest rates are not very useful as an instrument policy in Singapore. Instead, the use of exchange rates as a policy tool is a more significant tool to help Singapore achieve her economic goals.

Exchange Rates

  • Since Singapore is highly dependent on imports (for both consumption and production), as well as exports (as driver of growth), it is more important for the government to control the exchange rate of SGD.
  • Main objective of MAS exchange rate policy is to achieve price stability (low inflation) because of Singapore’s dependence on imports (necessities as well as raw materials and capital goods), changes in prices of imports will have a strong impact on costs of production and domestic cost of living
  • MAS exchange rate policy is gradual appreciation of SGD. An appreciation would imply that for one unit of SGD, we are able to purchase more units of foreign currency.  An appreciation would help to reduce price of imports in SGD. This would lower the cost of production of firms who make use of imported raw materials and this would lead to an increase in the SRAS and decrease in GPL. The appreciation thus helps to curb the effects of imported inflation and helps to achieve price stability.
  • MAS’ policy of gradual appreciation also creates a sense of confidence in foreign investors. This could attract foreign direct investment into the country due to higher expectations of economic growth and hence profitability, as well as higher rate of returns when profits are converted back to the foreign investors’ home currency if the country’s currency continues to appreciate. This increase in foreign direct investments will improve the financial account, hence improving the balance of payments.

Evaluation:

  • As mentioned above, an appreciation would lead to a fall in AD and hence lower actual economic growth and lead to an increase in unemployment as less factors of production including labour is needed to produce the lower output. There is thus a conflict with other macro economic aims.
  • However, this negative effect on export competitiveness may be mitigated to some extent by the fall in prices of imported inputs (hence lower costs of production).
  • Exchange rate policy is thus a useful policy in the context of Singapore to maintain price stability given our unique characteristics. However, as mentioned, the gradual appreciation does result in a conflict with other macroeconomic objectives of actual economic growth as well as unemployment, due to an appreciation, there could also be a worsening of the trade balance as (X-M) falls.

Tax rates:

  • Taxes are involuntary payment of funds to the government by a household or firm for which the household or firm receives no good or service in return.
  • There are several different types of taxes that are imposed by the Singapore government however the main ones are likely to be corporate tax, personal income tax as well the goods and services tax (GST).
  • By altering the tax rates, the Singapore government can help to alter the AD through changes in the components of investments as well as consumption. At the same time, changes in the tax rates are likely to have impacts on the LRAS and hence affect potential economic growth as well.
  • At the same time, the use of progressive income tax rates helps to reduce income inequality and hence helps to increase equity.
  • The use of taxes has also been used to correct the overconsumption of demerit goods such as cigarettes. In Singapore tobacco tax is at 67% to make the purchase of cigarettes less affordable.

Evaluation

  • The use of lowering tax rates as a means to increase the productive capacity of our economy has been effective in helping Singapore attract and retain MNCs. Our low personal income tax rates have also helped to attract foreign talent to help supplement Singapore’s limited workforce.
  • However, the ability to continuously lower tax rates to remain competitive is limited and we are facing competition for other countries such as Hong Kong that have very competitive tax rates as well.
  • There is thus a need to undertake other supply side measures to increase the productivity of workers in Singapore to ensure that we are able to compete.

Conclusion/Synthesis

  • The use of interest rate as a policy option in Singapore is not effective due to the characteristics of the Singapore economy. Exchange rates as a policy tool are used as an alternative to interest rates to manage price stability in the Singapore economy.
  • The use of tax rates in Singapore is used as a complement to exchange rate policy to help ensure that Singapore is able to increase her export competitiveness and not just rely on prices of exports to compete.
  • In terms of relative significance, exchange rate policy has more room in trying to manage shocks to the Singapore economy while taxes are more rigid as the Singapore government cannot lower or raise taxes whenever it is faced with an economic downturn or economic boom. Hence, the use of tax rates as a policy tool is more of a long-term measure.

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