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(a) Explain why low inflation is an important macroeconomic aim of the Singapore government. [8]



(a) Explain why low inflation is an important macroeconomic aim of the Singapore government. [8]

Inflation is defined as a sustained and persistent increase in the general price level. There are different possible causes of inflation, such as demand-pull or cost-push inflation. According to economists, a generally low inflation rate of 2 to 3% is optimal for an economy; however, hyperinflation results in adverse internal and external effects on an economy. Therefore, price stability is considered one of the important, major macroeconomic aims of any government, and Singapore is not an exception.

Internal Effects

There are adverse internal effects on an economy due to inflation. First, there could be an increase in “menu costs” as businesses would have to change price lists on their menus and catalogues often when inflation occurs, therefore incurring high transaction costs. Inflation could also result in “shoe-leather costs”, for instance, when firms frequently move money in and out of financial institutions to get the highest possible returns. Hence, high transaction costs could be an internal problem generated by inflation.

Secondly, inflation could also lead to a redistribution of income. Fixed income earners would suffer as the real value of their income would decrease due to inflation. For instance, pensioners or people on fixed wages would suffer due to inflation as their incomes would be able to buy less goods and services. Variable income earners, such as insurance agents or property agents, might not suffer that much because their incomes could increase due to inflation. Simultaneously, inflation would reduce the real value of debt. Hence, debtors would gain while creditors would lose in terms of purchasing power. The amount of the debt repaid by the borrower would have a smaller purchasing power due to inflation. Hence, a redistribution of income in favour of variable wage earners and debtors would occur.

Third, inflation damages investment. This is because the real value of savings will fall and people might be inclined to consume and spend instead of saving. This fall in savings would reduce the amount of funds available for investment, hence increasing borrowing costs (interest rates would rise as a result). Inflation also creates uncertainty as it is difficult for businesses to predict costs and revenues, profits, and losses. This would lead to a fall in investment, which would limit the future economic growth of the economy as well as the productive capacity of the country.

External Effects

When it comes to the foreign sector, inflation also has adverse effects. Inflation could negatively affect the competitiveness of a country’s exports. With higher inflation, a country’s exports would become relatively more expensive compared to goods from other countries. Assuming that the demand for Singapore’s exports is price-elastic, this would mean a larger than proportionate fall in the quantity demanded of exports when Singapore’s exports are priced higher relative to other countries due to the effects of inflation. Furthermore, with a higher relative rate of inflation as compared to other countries, this would mean that domestically-produced goods are relatively more expensive as compared to imports. Consumers would then switch from locally-produced goods to purchasing imports instead, assuming these are close substitutes. Therefore, import expenditure would also increase.

The Balance of Payments (BOP) would therefore be affected. For a small and open economy like Singapore, which depends on exports to drive economic growth, inflation could greatly worsen the country’s current account and thus worsen the BOP, assuming the capital/financial account remains unchanged. As a small economy with no natural resources, Singapore is dependent on imports of raw materials. Therefore, this makes Singapore susceptible to imported inflation, where the rising prices of such imports would lead to a higher cost of production, hence leading to a spiral of higher prices. Due to the high import content of Singapore’s exports, this could lead to a higher price of Singapore’s exports, hence adversely affecting export competitiveness.

Conclusion

In conclusion, the higher the rate of inflation, the greater the adverse effects on the country, be it internal or external effects. There are many different policies that the Singapore government can potentially use to curb inflation, such as fiscal policy, monetary policy, and supply-side policies.


JC Economics Essays: Tutor's Comments - This is part (a) of a two part Economics examination question set by an Economics tutor who was one of my classmates at NIE (National Institute of Education), where we did the PGDE (Postgrad Diploma in Education) for Economics. She kindly allowed me to modify her essay to fit this post. However, despite the fact this Economics essay was written by an Economics tutor, under simulated examination conditions, the question still remains: how can I improve on this work? Now, try a little more "feeling-based" or even "emotion-based" questions - what do I feel is correct about this Economics paper? what do I feel is right about this paper? is it just right in length? does it address the question? and so on. You can get a right gut feel about an Economics paper if you have reviewed many related Economics questions and gotten a feel of what a correct answer will or should look like. On my Economics site here, I have many other related questions - do explore them and see the comments that I have given to my students, other fellow Economics tutors, and to professional Economics paper writers. Thanks for reading and cheers! 

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