Discuss which policies the Singapore government can adopt to reduce inflation.

Introduction:

Low inflation is one of the 4 macroeconomic aims of the government and given the impact of inflation on the economy, there is a need to consider which policy can be adopted to reduce inflation. The criteria needed to know which policy should be adopted will be based on i) effectiveness in alleviating the root cause of inflation, ii) minimal conflicts with other macro goals.

Body:

1) Exchange rate policy as the main policy to curb rising inflationary pressure.

–    Singapore has no natural resources, hence low prices of imported raw materials are especially important to keep inflation rate low. By maintaining a strong Sing dollar, it will be effective in curbing high imported inflation as price of imports will be cheaper in local currency.

  • Since Singapore also faces demand pull inflation, a gradual appreciation will also increase the price of exports in foreign currency. This will lead to a fall in demand for Singapore’s exports and export revenue will fall, causing AD to fall thus reducing inflationary pressure due to excess AD.
  • Furthermore, appreciation of S$ makes imports cheaper in S$ increasing quantity demanded. Given that demand is price elastic, expenditure on imports will rise. This also makes AD fall, reducing demand-pull inflationary pressure.
  • E: Given the small and openness of Singapore’s economy, the dependence on trade and imported inputs allow the appreciation of Sing dollar to better cope with the effects of inflation compared to other demand management policies since it tackles the root cause of inflation in Singapore.
  • On one hand, it is difficult to gauge how much the Sing dollar should be allowed to appreciate. If the Sing dollar is too strong, it may erode export competitiveness and also as a destination for investment which brings about a fall in national income.
  1. Another current policy used to curb cost push inflation due to structural rigidity is supply side policies. Some of these policies are meant to increase the productivity of workers so that the productivity can increase faster than the wages. This would help lower unit cost of production. Some measures to achieve this include Productivity and Innovation credit (PIC) scheme and the Worker improvement through secondary education (WISE) scheme which are meant to equip workers and firms to upgrade their capital or skills.
  • E: This policy not only curbs cost push inflation but it helps to increase the productivity capacity of the economy, in other ways reducing the effect of demand pull inflation as well.
  • However such supply side policies may involve huge government expenditure and it may take a long time to achieve the outcome of reducing inflation as compared to exchange rate policy or other demand management policies.
  • Other policies such as contractionary fiscal policy to reduce demand pull inflation can be considered. This involves a reduction in government expenditure to reduce AD as well as increase personal and corporate tax to reduce C and I. With a fall in G, C and I, AD will fall which helps to curb inflationary pressure.
  • E: However the effectiveness of the measure depends on the responsiveness of households and firms to the increase in tax rates.
  • Moreover, as rising exports is a main source of inflation for the country and exports take up a very big share of AD, a fall in government expenditure will not do much to lower AD. Thus fiscal policy may not tackle the root cause of inflation in Singapore.
  • Another measure that Singapore can consider is to influence money supply and thus interest rates. An increase in interest rate may reduce the consumption and investment due to rise in borrowing cost. As such since AD falls, demand pull inflation can be curbed.
  • E: However, since Singapore is an open and small country, the need for free flowing capital and the use of exchange rate policy makes it impossible to implement such policy. Also due to our small economy, Singapore is an interest rate taker thus unable to freely alter the interest rate. Trying to manage interest rate would be also very unstable for our economy since it may result in large inflow and outflow of hot money which in the end destabilise our exchange rate. Given the dependence on trade, this would adversely affect economic growth in Singapore.

In conclusion, the Singapore government has to consider a combination of policies in order to alleviate the effects of inflation. There is no one policy that Singapore government can adopt as it depends on the cause of inflation. In times when there is a high level of imported inflation and external demand is strong, a strengthening of the S$ would be an effective policy and in times when there is high cost-push domestic inflation with weak external demand, the government would have to rely more on supply-side policies that address the rising domestic costs. Furthermore if inflation is caused by domestic factors such as rising property and car prices, direct measures to cool down these markets will be more effective and immediate.