Singapore’s consumer price index (CPI) rose to 4.3% in December 2012, according to the Singapore Department of Statistics. Singapore’s 2012 inflation was 3rd highest reading since 1991.

a) Explain what is keeping inflation high in Singapore. [10m]

 

Introduction

  • Inflation is a sustained increase in the cost of living or the average / general price level leading to a fall in the purchasing power of money.
  • The rate of inflation is measured by the annual percentage change in consumer prices.
  • Inflation can come from both the demand and the supply-side of an economy
  • Inflation can arise from internal and external events

Body

Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets.

A rise in the rate of GST would also be a cause of increased domestic inflation in the short term because it increases a firm’s production costs.

Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages.

Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of the pound against other currencies might cause higher import prices for items such as foodstuffs from Australia or technology supplies from the United States – which feeds through directly or indirectly into the consumer price index.

Demand-Pull Inflation

  • Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap
  • When there is excess demand, producers are able to raise their prices and achieve bigger profit margins because demand is running ahead of supply
  • Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP
  • Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic

Main Causes of Demand-Pull Inflation

  • depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country’s exports.  If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output
  • Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending.  If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow
  • Monetary stimulus to the Global economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods” and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly. Since Singapore does not control interest rates, we are however an open economy and such global monetary stimulus inevitably has an inflationary effect at home.
  • Fast growth in other countries – providing a boost to Singapore exports overseas. Export sales provide an extra flow of income and spending into the Singapore circular flow – so what is happening to the economic cycles of other countries definitely affects Singapore.

Cost-Push Inflation

Cost-push inflation occurs when firms respond to rising costs, by increasing prices to protect their profit margins.

There are many reasons why costs might rise:

  • Component costs: e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.
  • Rising labour costs – caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation
  • Expectations of inflation are important in shaping what actually happens to inflation. When people see prices are rising for everyday items they get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the MAS calls “second-round effects” i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life. This is also known as a “wage-price effect”
  • Higher indirect taxes – for example a rise in the duty on alcohol, fuels and cigarettes, or a rise in GST. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.
  • A fall in the exchange rate – this can cause cost push inflation because it leads to an increase in the prices of imported products such as essential raw materials, components and finished products
  • Monopoly employers/profit-push inflation – where dominants firms in a market use their market power (at whatever level of demand) to increase prices well above costs

Cost-push inflation such as that caused by a large and persistent rise in the world price of crude oil can be shown in a diagram by an inward shift of the short run aggregate supply curve. The fall in SRAS leads to a contraction of national output together with a rise in the level of prices.  This is shown in the next diagram.

In conclusion, Singapore’s inflation is caused by a myriad of factors, mainly imported cost push as well as demand pull.

 

b) Discuss the policies that the Singapore Government can adopt to mitigate the problems associated with rising inflation. [15m]

Inflation is measured by the increase in the Consumer Price index (CPI). The CPI basket consists of more than 6,500 brands/varieties of goods and services commonly purchased by resident households. Traditionally, Fiscal, Monetary, Exchange rate and Supply side policies can be used to counter rising inflation. However it is important to know the causes before implementing the correct measure. In part (a) we have identified the causes and in this part of the essay we will evaluate the effectiveness of the policies that the Singapore Government can adopt to mitigate the problems associated with rising inflation.

In Singapore, some of the components of CPI are affected by the cost of imported goods (e.g. food), while some are affected by domestic cost pressures.

  1. The main drivers of Singapore’s high inflation today are domestic cost pressures, which stem from supply side conditions. Imputed rentals on owner-occupied accommodation (OOA) have been increasing on the back of a tight housing market. However, imputed rentals on OOA have no cash impact on households who already owned their homes.
  2. The increase in transport costs has been driven largely by the increase in Certificate of Entitlement (COE) premiums as a result of the lower supply of new COE quotas.
  3. The tight labour market in Singapore has also led to higher wages throughout the economy. When the cost of hiring a worker increases, businesses may charge higher prices for goods and services to offset the cost increase. As a result, the broad categories of healthcare, education as well as recreation in the CPI have recently experienced price increases to some extent.

The government keeps a close watch on consumer price developments from both imported and domestic inflation, and undertakes several measures to mitigate them.

Measures to mitigate imported inflation (Appreciation of Exchange Rate)

The Monetary Authority of Singapore (MAS) has allowed the Singapore dollar to appreciate so as to help mitigate higher prices of imports such as food and oil.

To keep the costs of prepared food affordable, the National Environment Agency (NEA) intends to adopt management models that can help keep costs low.  For example, NTUC Foodfare, a social cooperative, was appointed to run the new Bukit Panjang Hawker Centre on a not-for-profit basis.  In addition, NEA plans to add 10 more hawker centres across Singapore to provide affordable food options to Singaporeans.

In addition, the Retail Price Watch Group (RPWG), headed by Senior Minister of State for Trade & Industry and National Development, Mr Lee Yi Shyan, keeps a close watch on any excessive price increases of food and other daily necessities. For non-prepared food, the RPWG has worked with supermarkets, wholesalers, hawkers, and food courts to promote the availability of cheaper alternatives.  The RPWG’s supermarket members – NTUC FairPrice, Giant and Sheng Siong – have for various periods held constant the low prices of their housebrand products to help consumers cope with rising costs.

Effects of an appreciation on the Singapore’s economy

  1. Exports more expensive. The foreign price of SG Exports will increase Foreigners will find SG exports more expensive. Therefore with a higher price, we would expect to see a fall in the quantity of SG exports.
  1. Imports are cheaper. SG consumers will find that $1 now buys a greater quantity of foreign goods. Therefore, with cheaper imports we would expect to see an increase in the quantity of imports.
  1. Lower (X-M) With lower export demand and greater spending on imports, we would expect fall in domestic Aggregate Demand (AD), causing lower economic growth.
  1. Lower inflation. An appreciation tends to cause lower inflation because:
    • import prices are cheaper. The cost of imported goods and raw materials will fall after an appreciation, e.g. imported oil will decrease, leading to cheaper petrol prices.
    • Lower AD leads to lower demand pull inflation.
    • With export prices more expensive, manufacturers have greater incentives to cut costs to try and remain competitive.

Impact of appreciation on AD/AS

http://www.economicshelp.org/images/macro/fall-AD.jpg

Assuming demand is relatively elastic, an appreciation contributes to lower AD (or a slower growth of AD), leading to lower inflation and lower economic growth.

Evaluation of an appreciation

  • Elasticity. The impact of an appreciation depends upon the price elasticity of demand for exports and imports. The Marhsall Lerner condition stations that an appreciation will worsen the current account if (PEDx + PEDm >1)
  • The impact of an appreciation depends on the situation of the economy. If the economy is in a recession, then an appreciation will cause a significant fall in aggregate demand, and will probably contribute to higher unemployment. However, if the economy is in a boom, then an appreciation will help reduce inflationary pressures and limit the growth rate.
  • It also depends on economic growth in other countries. If Singapore was experiencing strong growth, they would be more likely to keep buying SG exports, even though they are more expensive.
  • It also depends why the exchange rate is increasing in value. If there is an appreciation because the economy is becoming more competitive, then the appreciation will not be causing a loss of competitiveness. But, if there is an appreciation because of speculation or weakness in other countries, then the appreciation could cause a bigger loss of competitiveness.

 

Measures to mitigate domestic cost pressures (Supply Side Policy)

While housing prices are not part of CPI inflation, they are of concern to young families, especially those that do not yet own their homes. The Ministry of National Development has taken significant steps to boost the supply of Build-to-Order (BTO) HDB flats and private residential property. The subsidies for HDB flats are also regularly reviewed to ensure that public housing are affordable, especially for first-time buyers. The government has also implemented a number of demand management measures, and will continue to monitor the housing market closely.

To manage the possible impact of a tight labour market, the government works with unions and companies to raise productivity. This can be achieved through improving the production processes of companies, as well as encouraging workers to upgrade their skill sets. With enhanced productivity, firms will be able to pay their workers better salaries and cope with higher business costs, without the need to pass on the increased costs to consumers.

At the individual household level, the government also provides cash grants directly to help mitigate the impact of rising costs on households.  For example, the U-Save rebates are provided to help HDB households directly offset their utilities bills. Although these grants do not reduce CPI inflation, they help to cushion the impact of the rising cost of living experienced by households.

The effects of supply-side policy

Successful supply-side policy will shift the AS curve to the right.

The advantages of Supply Side policy

  1. Supply-side policies can help reduce inflationary pressure in the long term because of efficiency and productivity gains in the product and labour markets.
  2. They can also help create real jobs and sustainable growth through their positive effect on labour productivity and competitiveness. Increases in competitiveness will also help improve the balance of payments.
  3. Finally, supply-side policy is less likely to create conflicts between the main objectives of stable prices, sustainable growth, full employment and abalance of payments. This partly explains the popularity of supply-side policies over the last years.

The disadvantages

  1. However, supply-side policy can take a long time to work its way through the economy. For example, improving the quality of human capital, through education and training, is unlikely to yield quick results. The benefits of deregulation can only be seen after new firms have entered the market, and this may also take a long time.
  2. In addition, supply-side policy is very costly to implement.  For example, the provision of education and training is highly labour intensive and extremely costly, certainly in comparison with changes in interest rates.
  3. Furthermore, some specific types of supply-side policy may be stronglyresisted as they may reduce the power of various interest groups. For example, in product markets, profits may suffer as a result of competition policy, and in labour markets the interests of trade unions may be threatened by labour market reforms.
  4. Finally, there is the issue of equity. Many supply-side measures have a negative effect on the distribution of income, at least in the short-term. For example, lower taxes rates, reduced union power, and privatisation have all contributed to a widening of the gap between rich and poor.

In conclusion, due to our small and open nature, Singapore primarily employs the exchange rate and supply side policy to mitigate inflation. Such policies has proven to be effective albeit some of it’s side effects as mentioned in the essay above. Singapore must continue to be vigilant and ready to deploy an array of policies to maintain a sustainable rate of inflation.