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


Introduction: Causes of Inflation in Singapore

This Economics paper discusses the likely causes of  inflation in Singapore. First, a few definitions are in order. 

What is inflation? Inflation occurs when there is a persistent and sustained rise in the general price level of goods and services, and is a macroeconomic problem when the rise in general price level is persistent and inordinate. With inflation, a given amount of nominal income buys fewer goods and services than before, which poses socio-political problems in countries that suffer from inflation. 

Inflation caused by the demand-side is known as demand-pull inflation while inflation caused by the supply-side is known as cost-push inflation. This paper argues that both demand-pull and cost-push inflation are present in Singapore, but cost-push is far more important to the Singapore economy, especially when it comes to imported inflation in Singapore's case. 

Demand Pull Inflation in Singapore 

What is demand pull inflation? Firstly, demand-pull inflation occurs in Singapore when Aggregate Demand (AD) rises as the economy is at or near the full employment level of national income. 

Why would AD rise, or what are the factors causing AD to rise? There are many reasons why AD will rise, but they can all be attributed to the components forming AD, which are C, I, G, and (X-M), as AD = C + I + G + (X-M). 

[Tutor's Note: Draw and explain the correct AD/AS diagrams. Think also - where do the diagrams fit in, have I labelled them correctly, and what do these economics diagrams show the reader?]

First, it can be argued that 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. However, this is not that likely in Singapore's case, given her unique context. 

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. This is slightly more likely in Singapore's case. 

Lastly, factors like increases in government spending (G), for instance on the Singapore Armed Forces or Singapore Police Force, and increases in net exports (X-M), due to foreigners buying more of our domestically produced exports, will also cause AD to rise, leading to demand-pull inflation in Singapore as the GPL increases. This is also quite likely in Singapore, but there are also supply side factors to inflation to consider. 

Cost Push Inflation in Singapore

On the other hand, demand is not the full picture when it comes to inflation. 

What is cost push inflation? Cost-push inflation occurs when Aggregate Supply (AS) rises due to economy-wide rises in production costs. As labour cost is often the largest component of total costs in Singapore, a sudden rise in wages can cause significant cost-push inflation in Singapore. 

However, having said that, rising food, fuel, property prices, exchange rates and the foreign sector are also factors that cause AS to rise, leading to cost-push inflation as the general price level increases when the AS curve shifts upwards. 

[Tutor's Note: Draw and explain the correct AD/AS diagrams. Think also - where do the diagrams fit in, have I labelled them correctly, and what do these economics diagrams show the reader?]

Imported Inflation in Singapore

Imported inflation can lead also lead to cost push inflation. As Singapore is a small and open economy with limited natural resources (factors of production), she has to depend heavily on imports from other countries for both her consumption goods and factor inputs. In fact, Singapore's exports are made from imported inputs. Thus, the biggest threat to inflation in Singapore would be the depreciation of the Singapore Dollar (SGD). This could be due to lack of export competitiveness which lowers the demand for Singapore's currency, or this could also be due to Singapore dollars flooding the foreign exchange market. 

If the Singapore dollar depreciates too quickly, it causes severe imported inflation which impacts households directly through rising goods, food, and energy prices. Imported inputs also become more costly, thus raising production costs and product prices, and since Singapore's exports depend on imported inputs this has a massive knock on effect on Singapore's exports.

With small domestic market, highly export-oriented Singapore is 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 could trigger a recession. Hence, Singapore’s central bank, the Monetary Authority of Singapore (MAS) has a primary objective to promote price stability through Singapore's version of monetary policy, which is a kind of exchange rate policy. 

[NOTE: In order to effectively manage Singapore’s exchange rate, the MAS could potentially buy back its own currency from the foreign exchange market which reduces the money supply to raise the Singapore exchange rate. Conversely, the MAS also could sell domestic currency on the foreign exchange market which raises the money supply to lower the Singapore exchange rate.]

Conclusion

Hence, imported inflation is the most important factor affecting Singapore's economy and is the most likely cause of inflation in Singapore, along with cost push inflation, and with demand pull inflation being the least likely form of inflation in Singapore. 

JC Economics Essays: Tutor's Comments - This Economics essay is approached in a rather different way from this other essay, also here on this site, on inflation in Singapore's case: Singapore's Inflation: Explain the causes of inflation in Singapore. Compare and contrast. Why is this the case, which economics essay approach is better, and how could you improve on either of these papers? Do also think about why the approaches from different students can vary considerably when answering or responding to the same question. Which approach or angle is more useful and relevant in crafting an excellent economics essay, especially when under time pressure? Also, there are a few small problems with this economics essay - can you spot these small errors or mistakes, and improve on these flaws or inadequacies? Think about it for a moment. If you can identify the mistakes or the small inadequacies, plus suggest improvements upon them, then clearly you are in a good position and have really understood the material. This economics essay is a contribution from my companion website and has been adapted and amended a bit. Thanks for reading and cheers! 

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