China's Economy: Discuss the implications of a revaluation of the Chinese yuan on Singapore’s economy. [25]

In recent years, economists worldwide argued that China should revalue her yuan, or shift away from her dollar peg, because her yuan (RMB) has been viewed as undervalued. (Year 2010-2012).

Discuss the implications of a revaluation of the Chinese yuan (RMB) on Singapore’s economy. [25]

Introduction

The Chinese yuan (reminbi, RMB) has long faced revaluation pressures with China’s mounting trade surpluses and developed countries’ claims of China dumping cheap goods on their markets, flooding their economies with low-priced goods “Made in China”. 

This paper argues that, as an increasingly dominant trading partner for Singapore, if China were to revalue the yuan, it would have a huge impact on Singapore’s economy. Revaluation, an increase in the value of the Chinese yuan, will impact the Singapore economy through imports from China, exports to China, and the concomitant effects on the balance of payments, and may thus impact Singapore’s economic growth and national income.

Imports: Imported Inflation

First and foremost, Singapore imports a large variety of goods from China, as Singapore relies on many Chinese intermediate goods as inputs for production of exports for her export sectors. As these are inputs or necessities needed in Singapore, the demand for these goods is relatively price inelastic, and thus the revaluation of the yuan, which makes Singapore’s imports from China more expensive, would likely raise Singapore’s import expenditure. 

Most importantly, because Singapore relies on Chinese inputs for production of both exports and also domestically consumed goods, a revaluation of the yuan would result in imported inflation in Singapore, as the prices of domestic goods will rise to account for the rising costs of production due to the increased costs of raw materials in terms of Singapore Dollars. 

Inflation is defined as a persistent and sustained increase in the general price level, and can be divided into demand-pull and cost-push inflation. In this case, cost-push inflation in terms of imported inflation would result from a revaluation of the yuan.

Exports: Earning?

However, on the other hand, Singapore’s exports to China would increase due to a revaluation of the yuan, ceteris paribus. A revaluation of the yuan, without any corresponding rise in the value of the Singapore dollar to offset the relative effect, would result in Singapore’s exports to China appearing cheaper in yuan. With the growing middle class in China and their rising disposable income, consumption of imports is rising in China, and Singapore can benefit from this boom. 

Yet, it has to be argued that the problem is that Singapore depends heavily on imported inputs, being a small and open economy, and as such it is likely that the increased exports to China would be less than the increased costs of imports, which are often needed to produce output in Singapore. This results in a catch-22, because the inflation from the imported inputs, which makes Singapore’s exports more expensive, would counter the relative price effects of the revalued yuan.    

Balance of Payments: Trade Deficit?

Therefore, the revaluation of the yuan would worsen Singapore’s balance of payments, possibly causing a growing trade deficit with China, thus hampering the Singapore government’s goal of a healthy balance of payments surplus. 

The balance of payments refers to the accounting record of all monetary transactions between a country and the rest of the world, and can be classified into the different components of the current account, capital account, financial account, and (statistical) balancing item. There could be a trade deficit for Singapore if (X-M) falls.

Damage to Singapore’s National Income and Growth

Furthermore, as China is one of Singapore’s emerging exporting market and increasingly important trade partner, given Singapore’s economy as one being driven by trade, the revaluation of the yuan can affect Singapore’s national income adversely. Economic growth can be thought of as increases in the Gross Domestic Product (GDP) of a country, and can be classified into potential and actual growth. 

First, potential growth could be hampered due to the rising input costs from goods we buy from China from Singapore’s perspective. Although potentially Singapore’s actual growth might improve if AD goes up due to rising X, this could be offset by long term damage to our potential growth. 

Furthermore, if Singapore’s exports are affected because unit costs have risen due to imported inflation because Singapore uses foreign inputs to produce exports, as argued earlier, then X might fall in the long run, and also cause actual growth to slow down. Hence, potentially a rise in the yuan could potentially and possibly lead to both lack of potential and actual growth for Singapore’s economy. Thus, while export revenue might increase in the short term, as Singapore is small and open, the higher costs of imported inputs from China would have detrimental effects and as such, the revaluation of the yuan has largely negative implications on Singapore’s BOP.

Policies and Conclusions

Since the export sector of (X-M) takes up a huge proportion of Singapore’s national income because Singapore is a open and small economy, falling net export revenue from China can potentially reduce Singapore’s rate of growth by shifting her AD to the left, unless this is cushioned by rising export revenues with other trading partners, like the USA and the European Union. 

However, that seems unlikely in the intermediate term given the global financial crisis and recent Eurozone crises and the concomitant recessions worldwide. Fortunately, as long as the Monetary Authority of Singapore allows an appreciation of SGD, ahead of the revalued yuan, the adverse impact of the revaluation on Singapore’s economy would likely be minimal. Singapore pursues an exchange rate policy using a managed float exchange rate system in place of a “standard monetary policy”. A strong Singapore Dollar keeps imported inflation low by maintaining the low cost of her imports. 

In conclusion, the implications of a revaluation of the yuan on the Singapore economy are most likely negative overall, but Singapore has the appropriate policy tools in exchange rates and monetary policy to manage and mitigate these impacts and will use them if need be. Hence, to a large extent, the discretionary powers of the MAS would be useful in mitigating the effects of a revaluation in the yuan. 

Junior College Economics Essay: Tutor's Comments - This Economics paper was written and contributed by a Chinese student from China. This Economics essay has to be praised: first of all, it was composed and written under H2 JC Economics examination conditions; second of all, the language is good, refined, and proper; third, the content knowledge is there, and there is wide understanding of both the Singapore and the Chinese economies. There is good application of economics knowledge and concepts, and there are also empirical evidence and current affairs discussions. As an Economics tutor, this is one of the best Economics exam pieces that I have seen by a Chinese student, and it goes to show that when students work hard, study hard, and try their best, they can achieve, grow, learn, and develop rapidly. If they want to, they can put their heart into learning and studying Economics. As usual, do think of how you can improve upon this work and how you would approach this essay. Maybe, try to write out the answer without referring to this sterling Economics essay? It has also to be admitted that this Economics paper is (of course) not perfect: What other economics concepts, theories, and knowledge could you bring in to make the discussion richer? Thanks for reading and cheers. 

Discuss whether the undervalued yuan (RMB) is the only cause of China’s rising inflation and trade surplus with the US. [25] (Rephrased Economics Question)

In recent years, it has been argued that the undervalued renminbi (RMB / yuan) is the major cause of China’s burgeoning inflation and massive trade surplus vis-à-vis developed countries, especially the USA. From 2007-21012, economists worldwide argued that China should revalue the yuan.

Discuss whether “the undervalued yuan” is the only cause of China’s rising inflation and huge trade surplus with the USA. [25]

Introduction

China has often been accused by the West of using her fixed exchange rate to maintain an “undervalued yuan”, meaning that her currency (yuan, renminbi, RMB) is cheaper than it otherwise should be in a floating exchange rate, relative to other currencies. 

This Economics paper argues that having an undervalued currency encourages demand for Chinese exports, which could arguably lead to demand-pull inflation, whilst concomitantly causing imported inflation for China, as its imports from its trading partners are relatively more expensive. Hence, it can be strongly argued that China’s inflationary woes indeed stem in part from an undervalued yuan, and, to a large extent, the high demand for low-priced Chinese exports is responsible for China’s huge trade surplus.

Inflation

First and foremost, it has to be argued that China’s inflationary woes stem partly from the undervalued RMB. With a relatively undervalued RMB, Chinese goods appear cheaper relative to other countries’ goods, and this causes an increase in the demand for Chinese exports, in contradistinction to other countries’ domestically produced goods or even goods from other exporting countries. This is because with increased demand for Chinese exports, (X-M) increases, and since AD = C + I + G + (X-M), there arises demand-pull inflation. Inflation is defined as a persistent and sustained increase in the general price level, and demand-pull inflation is caused by rapid and persistent increases in AD.

On the cost-push side, the undervalued yuan may have made imported inflation a real possibility and thus may have pushed up the AS curve. This is because if China imports inputs or factors of production, especially and furthermore so if those natural resources are then used as inputs to produce exports, then this might cause inflation in China if these inputs rise in price. Given that the cheaper yuan makes other countries’ currencies look more expensive, this is a real possibility.

Inflation in China, on the other hand, is also caused by the rapid growth they experienced in recent times. There has been rising domestic consumption due to the rapidly expanding middle classes in China, and that would have raised C. At the same time, rising optimism about business prospects have led firms to undertake investments, thus raising I as well. Since AD = C + I + G + (X-M), it is clear that these increase AD. Hence, AD also shifts to the right, thus causing demand-pull inflation due to rapid domestic Chinese economic growth, which is not solely related to growth in exports.

Trade Surpluses

Secondly, the “undervalued yuan” can be blamed for the mounting trade surplus China has with its trading partners, predominantly America, since American consumers’ high demand for cheap Chinese goods caused the Chinese to sell massive amounts of goods to Americans. As China uses a fixed exchange rate regime, this balance of trade disequilibrium is not automatically corrected, unlike under a freely floating exchange rate regime. Concomitantly, prices of imports remain relatively high, from the Chinese perspective, since the yuan was kept low. This leads in theory to import expenditure being low, whilst export expenditure is high. Hence, the low value of the Chinese yuan will continue to encourage other countries to import cheap Chinese goods, and thus incur a growing trade deficit; on the other hand, China will, theoretically, continue to accumulate surpluses given the low value of the yuan. Hence, it seems that the criticisms of the undervalued yuan seem justified here.

Other Countries’ Declining Comparative Advantage

Nonetheless, the “undervalued yuan” cannot be the only cause of this huge trade surplus; America’s slowly declining comparative advantage, where comparative advantage refers to the relatively lower opportunity cost of a country in producing a good relative to other trading countries, in manufacturing has led to weakening US exports, whilst, on the other hand, it might be possible to argue that China has developed a new, dynamic comparative advantage in manufacturing, especially cheap and lower-end products. For instance, the American steel industry has been too reliant on protectionism for many years, and this has contributed to her mounting trade deficit, because it has become less export competitive, while the Chinese improved consistently over recent years. Hence, perhaps the trade surpluses are due to American weaknesses and Chinese strengths.

Conclusion

Thus, while it can be strongly argued that the “undervalued yuan” does indeed have a part to play in China’s rising inflation and huge trade surpluses, it cannot be considered the only cause of these problems, and China’s increasing prosperity, especially for the middle classes, her rising economic growth, and the falling productivity and comparative advantage of the developed nations who are her trade partners are realistic and relevant alternative explanations for the same phenomena. 

JC Economics Essays: Tutor's Comments - This Economics essay was actually written under examination conditions by a Chinese student. First, it has to be praised: the English is very well written and fluent, and the student has clearly got a very good understanding of the Chinese economy and a good knowledge of international economic events. Secondly, it has to be said that the quantity and quality of this Economics essay far exceed what I would have expected as an Economics tutor, because this was written under examination conditions and by someone whose native language is not English. This just goes to show that if one puts one heart into doing something, and tries one's best - one can achieve many great things in life. As an Economics tutor, seeing such work and effort in my students' Economics essays is one of the joys of teaching. If you were to write this essay, how would you approach it? Would the approach be similar or different? Thanks for reading and cheers. 

Discuss the extent to which globalisation has helped Singapore achieve its macroeconomic objectives. [25]

Discuss the extent to which globalisation has helped Singapore achieve its macroeconomic objectives. [25]

This paper discusses the extent to which globalisation has helped Singapore achieve its macroeconomic objectives. Globalisation refers to the integration of economies through greater flows of trade, capital, labour, and technology across international borders. Singapore’s four main macroeconomic objectives are high and stable economic growth, a low inflation rate, low unemployment, and a favourable balance of payments (BOP). To a large extent, globalisation has helped Singapore achieve its macroeconomic objectives; however, globalisation brings with it downsides which have to be properly mitigated.

Economic Growth

First, globalisation has helped Singapore attain actual economic growth through increased international trade. Actual growth means an actual increase in real Gross Domestic Product (GDP), a shift in Aggregate Demand (AD) to the right. An increase in net exports (X-M) to the rest of the world raises AD, which in turn leads to a more than proportionate increase in GDP via the multiplier effect. Singapore has relied heavily on exports for economic growth. In fact, net exports make up the largest component of Singapore’s GDP. Increasing actual growth also helps Singapore achieve full employment, or alternatively low unemployment.

Second, large amounts of foreign direct investment (FDI) have helped Singapore achieve potential economic growth. Potential growth is the increase in the economy’s potential capability to produce output. Transfers of physical capital, human capital, and technology from Multi-National Corporations (MNCs) have helped increase the Singapore economy’s productive capacity, and thus shifts Singapore’s long-run Aggregate Supply (LRAS) curve to the right, increasing her potential economic growth.

Third, Singapore has also benefited from increased labour flows across international borders. Importing foreign labour leads to an increase in Singapore’s labour which raises the economy’s productive capacity. This is a relatively efficient and cost-effective way of increasing potential growth.

Low Inflation

Fourth, globalisation has helped Singapore keep inflation low. Inflation is defined as a persistent and sustained increase in the general price level, and it is generally seen as a problem. By importing raw materials from other countries at low prices, Singapore has been able to lower her costs of production which translates to lower prices for final products. Importing necessities and other finished products helps keep the general price level down. Also, globalisation increases the Singapore economy’s productive capacity which lowers prices. This is reflected by a rightward shift of the Long Run Aggregate Supply (LRAS) curve, which increases Singapore’s productive capacity in the long run, and concomitantly lowers prices and prevents cost-push inflation.

Low Unemployment

Fifth, globalisation helps to keep Singapore’s unemployment low. Increased export levels shifts AD to the right which in turn leads to higher equilibrium national output. This means that actual growth occurs, which shifts AD towards the full employment level, which lowers unemployment.

BOP

Finally, Singapore is able to have a positive net-export position by importing cheaper raw materials from abroad and exporting high value-added products. For example, Singapore imports crude oil from abroad, refines the oil, and then exports it to different countries. Because the value of Singapore’s exports exceeds the value of her imports, she has a current account surplus, which could translate into a BOP surplus, assuming the deficit in the financial or current accounts are not huge.

Downsides of Globalisation

Yet, despite all its apparent benefits, globalisation has some downsides which could possibly derail Singapore’s macroeconomic aims.

First, Singapore’s dependence on exports makes her vulnerable to negative economic conditions in other countries. If one of Singapore’s trading partners were to experience a recession, demand for her exports would fall. This reduces AD which leads to lower equilibrium national output. Thus, the Singapore economy is susceptible to demand shocks. For example, Singapore’s GDP decreased during the financial crisis of 2007/2008. Thus, while globalisation might confer growth, it also means that same growth could potentially be more volatile.

Second, while globalisation gives Singapore a bigger market for her exports, it also means that she could face more competition. Developing countries, like China, are catching up quickly. Singapore has already lost her comparative advantage in low- to medium-end manufacturing to rapidly industrialising countries. If exports decrease due to competition from low-cost countries, it will result in a fall in AD, which would lead to a drop in output. Over the years, Singapore has had to move up to higher value-added goods and services like biomedical or financial services in order to remain competitive.

Third, increases in Singapore’s productive capacity brought about by globalisation might not be permanent because she is highly reliant on MNCs which are by nature internationally mobile. They could shift operations to a lower-cost location, taking capital with them. There is also no guarantee that Singapore’s “foreign talent” will stay in the country for the long term. Furthermore, importing foreigners to increase Singapore’s labour is also unsustainable in the long term given Singapore’s small land size because the influx of foreigners, perceived to be competing with Singaporeans for jobs and space, has become a major source of political and social discontentment and political acceptability is a major issue. Thus, potential growth might be illusory and fraught with many potential political perils.

Fourth, if the Singapore economy is already operating at or near full employment, then a rise in AD due to increased exports could possibly and realistically lead to demand-pull inflation. Singapore’s persistently low unemployment rate suggests that her economy is operating at close to full employment already. Thus, inflation could be a potential problem.

Fifth, importing raw materials from abroad also leaves Singapore vulnerable to cost-push inflation, more specially imported inflation. For example, Singapore was affected by the rise in oil prices due to political uprisings in the Middle East. Hence, Singapore is vulnerable to supply shocks.   

Sixth, should Singapore lose export competitiveness, (X-M) will become negative which would mean a current account deficit and a likely BOP deficit. Weak demand for exports would result in a depreciation of the Singapore dollar which would increase the price of imports. A depreciation of the Singapore dollar is likely to be inflationary given Singapore’s dependence on imported raw materials, and because it becomes more expensive to buy imported inputs which Singapore needs to produce goods. A deficit in the BOP also means a decline in the country’s foreign reserves which means that if Singapore has few foreign reserves, her currency will be vulnerable to speculative attacks.

Seventh, globalisation could also potentially be harmful for employment. Singapore’s heavy reliance on exports means that she will experience high cyclical unemployment should her major trading partners enter recessions. Perhaps, even more worrying is the increase in structural unemployment because lower-skilled workers could find their jobs being outsourced. Even if their work cannot be easily shifted abroad, they face competition from foreign workers willing to work longer hours and at lower wages. Concomitantly, there is a shortage of workers able to take on high-skilled jobs created by the global economy. As such, Singapore has had to import “foreign talent” to fill this gap. Therefore there are many negative implications for the labour market.

Conclusions

In the final analysis, despite many drawbacks, globalisation has been largely beneficial for Singapore. This is mainly due to the way in which the government has managed to tap into opportunities offered by a globalised world. For example, by providing necessary infrastructure, low tax rates, and a highly-skilled workforce, the government created conditions conducive for international trade and economic growth. At the same time, the government has been able to mitigate some of globalisation’s downsides through her economic policies. Singapore could and does use exchange rate policy. The Monetary Authority of Singapore (MAS) has the discretion to allow the Singapore dollar to appreciate in order to mitigate the inflationary effect of rising prices. Hence, to a large extent, globalisation has helped Singapore achieve its macroeconomic objectives; however, globalisation also brings with it several downsides which have to be properly managed.

JC Economics Essays: Tutor's Comments - This paper was modified and amended from one of the Economics essays written by my friend and classmate from NIE (National Institute of Education). After NIE, he became an Economics tutor at Raffles Institution (the JC section). [Special thanks and acknowledgements to my classmate's contribution.] This Economics essay is about globalisation and the impacts on Singapore's macroeconomic goals and aims; it also discussed policy options and methods to tackle impacts. There are many other globalisation and Singapore economy Economics questions and answers on my site here; do take your time here to explore and read, review, and study the other questions and answers. Compare and contrast them; think through them as well. Alright, here it is time to do the usual tutor's exercise once again: imagining that you are an Economics tutor, examining and marking this paper, what would you look out for? What would you consider a valid, reasonable, nuanced, and balanced argument or point? As an Economics tutor, how would you grade this paper, and why? Thinking through these processes will help you in writing better and better Economics essays, and improve your understanding and knowledge of this interesting and exciting subject. Thanks for reading and cheers!

(b) "Fiscal policy works best to achieve price stability in a small and open economy like Singapore." To what extent do you agree with this assertion? [17]

(b) "Fiscal policy works best to achieve price stability in a small and open economy like Singapore." To what extent do you agree with this assertion?

Inflation brings about some adverse effects to the economy and hence it is important for governments to implement policies to curb inflation. The policies used would differ according to the type of inflation as well as the nature of the economy. This paper discusses if fiscal policy works best to achieve price stability in a small and open economy, and uses Singapore as a case study in particular. First, it should be noted that Singapore is a small and open economy with no natural resources, relying heavily on trade, international capital flows, and foreign direct investments to drive growth. This paper argues that fiscal policy can be used, but its impacts are massively limited given Singapore’s context.

What is fiscal policy?

Fiscal policy refers to the manipulation of government expenditure and taxation to achieve macroeconomic goals. A contractionary fiscal policy could be used to curb inflation. Government expenditure could be reduced or taxation could be increased. With a lower government expenditure, this would translate to a lower aggregate demand (AD) which consists of AD = Consumption + Government expenditure + Investment + Net Exports, or AD = C + I + G + (X-M).

Through the multiplier process, a fall in G would lead to a multiple fall in AD. With a fall in AD, firms would accumulate inventories and this would be a signal to reduce production and output. Firms will reduce their number of workers hence resulting in a fall in output and a rise in unemployment and a fall in national income. With a fall in household incomes, there is a fall in spending and hence through the multiplier process, this would result in a contractionary effect on the economy. Hence, AD would shift to the left as shown, resulting in a fall in the general price level.

With higher taxes such as income taxes, this would reduce the disposable incomes of consumers and hence this would also reduce consumption expenditure, shifting the AD curve to the left, and, hence, also resulting in a fall in the general price level.

Limitations of Fiscal Policy in Singapore’s Context

However, the effectiveness of fiscal policy would depend on the size of the multiplier. In the case of Singapore, the size of the multiplier is small due to the high marginal propensities to save and import. This is firstly due to compulsory savings such as the Central Provident Fund (CPF), and, secondly, a high marginal propensity to import, among other factors. Because Singapore is a small and open economy that relies heavily on foreign trade, there would be high leakages from the economy. Also, it would also be difficult to reduce government expenditure for long-term, major projects. Increasing personal income tax could also result in a disincentive to work and a higher corporate tax could drive businesses away from Singapore.

Other Possible Solutions

On the other hand, the Singapore government can also use contractionary monetary policies (in Singapore’s case, an exchange rate policy), or supply-side policies instead to tackle inflation, rather than just fiscal policy.

Monetary Policy, in Singapore’s Context

Monetary policy refers to the use of interest rates to achieve macroeconomic objectives. In Singapore’s case, her monetary policy is tied to exchange rates, and Singapore uses a form of exchange rate policy because Singapore is dependent on external demand. Therefore, it is more effective to control exports and imports in Singapore’s context. Hence, the exchange rate is used as a tool of monetary policy in Singapore instead.

In Singapore, a managed float system is adopted where the Singapore dollar is allowed to fluctuate within a band against a basket of currencies of her trade partners. The central bank will then intervene in the foreign exchange market to move the exchange rate to a desired level by buying up or selling the Singapore dollar using her foreign reserves, when the currency level approaches the bands. For instance, to curb inflation, the Singapore central bank (the MAS) could buy up the Singapore dollar, resulting in an appreciation of the Singapore dollar. This appreciation of the Singapore dollar would lead to a fall in the price of imports in terms of Singapore dollars. This would lead to a lower cost of living as the price of imported products would be lower. With a lack of natural resources, Singapore depends heavily on imports as inputs to manufacture our exports. Therefore, the fall in the price of imports would lead to a fall in the cost of production.

The lower price of imports would also mean that consumers switch away from local goods and purchase more imports instead, assuming they are substitutes. With an appreciation of the Singapore dollar, this would mean that Singapore’s exports are more expensive in foreign currency terms and hence less price-competitive. Assuming demand for exports to be price-elastic, this would lead to a more than proportionate fall in quantity demanded of exports from Singapore. If the Marshall-Lerner condition holds, this would lead to a fall in net exports and hence a fall in AD. The AD curve would shift to the left, resulting in a fall in the general price level, ceteris paribus.

Limitations of Singapore’s Exchange Rate Policy

However, there are limitations to the effectiveness of Singapore’s exchange rate policy. Intervention in the foreign exchange market to generate an appreciation of the currency would require Singapore to maintain significant reserves. A fall in export earnings through an appreciation of the dollar would also lead to a worsening of the current account.

On the other hand, besides fiscal and monetary policies, the Singapore government could also use supply-side policies to tackle both demand-pull and cost-push inflation. With supply-side policies, the aggregate supply (AS) could be increased through labour retraining and education. By increasing the productivity of workers, in the long run, the cost of production would fall, resulting in a rightward shift of the LRAS curve, leading to a fall in the general price level, ceteris paribus. Cost-push inflation can also be curbed using wage and income policies. For instance, a flexible wage structure would enable wages to be adjusted downwards. In Singapore, the National Wages Council (NWC) recommends the level of wage increases. This could control labour costs and ensure that wage increases do not outstrip productivity increases.

However, supply-side policies would not work effectively if AD continues to increase. Therefore, there is a need to use both contractionary fiscal or monetary policy to reduce AD to reduce the upward pressure on prices. In the long run, supply-side policies are important to curb inflation.

Conclusions

In concluding, it should be mentioned there could also be considerable time lags involved in the implementation of policies. It takes time for policymakers to gather data. There could also be implementation lags due to the time taken to implement suitable policies. Once policies are implemented, there could also be impact lags as it takes time for policies to take effect. Also, due to the characteristics of the Singapore economy, it is arguably better to adopt contractionary monetary policy using exchange rates to curb inflation, as Singapore’s monetary policy is in the form of exchange rate policy. This poses a tricky problem, in that, with a small multiplier in Singapore’s context, the effectiveness of fiscal policy is limited, yet the benefits of supply-side policies might only be reaped in the long run. However, it should also be noted that curbing inflation could lead to a trade-off with another macroeconomic objective of unemployment. By curbing inflation, a fall in national output will occur and that might lead to an increase in unemployment. In the final analysis, fiscal policy is only one of many solutions and its impact is massively limited in Singapore, and as such as plethora of policies should be used instead of one single policy.

JC Economics Essays: Tutor's Comments - This paper was written by an Economics tutor friend of mine, who was my former classmate at the NIE (National Institute of Education), doing PGDE (Postgraduate Diploma in Education, JC, Economics specialisation). For part (a) of this question, see the suggested "model" Economics answer why low inflation is an important macroeconomic aim of the Singapore government.  My usual tutor's comments and questions apply here to this essay: what do you like about this paper, and what have you learnt here? Also, what have you studied that is different or similar to what is written in this Economics paper? Using your knowledge of macroeconomics, what diagram must you use here to explain the words? Remember, although this was written under simulated examination conditions by an Economics tutor, you can always think of other ways to improve it, refine it, and make it better suit the context. Also remember that you should know how and when to apply your Economics concepts and theories, rather than just merely memorising and regurgitating. Be sure to think hard, clearly, and properly when writing your Economics essays, especially during examination conditions. Thanks for reading, and cheers!

(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! 

“Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]

(b) “Governments should focus primarily on a low and stable rate of inflation.” Discuss. [15]

This essay discusses the macroeconomic aims of governments. This essay argues that, while low inflation is an important macroeconomic aim, governments should also focus equally on other macroeconomic aims such as low unemployment, economic growth, and a stable balance of payments. There are a few types of policies that governments can use to achieve their aims. First, monetary policy is the manipulation of monetary variables such as money supply, interest rate and the exchange rate. Second, fiscal policy refers to the use of government spending and taxation to achieve macroeconomic objectives. However, other than such demand-side policies, governments can also use supply-side policies, which increase the quantity and quality of resources, and improving technology.

Targeting Inflation

First and foremost, clearly there are good reasons for governments to use demand-management or supply-side policies to tackle inflation. This is because a persistent and sustained increase in the general price level hurts fixed-income wage earners and retirees on pensions, as well as consumers of goods and services, who find that their incomes buy fewer goods and services. Inflation reduces the real value of their incomes. In addition, inflation makes it difficult for trading and exchanges within an economy, for instance due to menu costs – the costs of constantly updating prices. Furthermore, inflation makes it difficult for a country to engage in international trade. This is because cost-push inflation reduces the competitiveness of a country that depends on exports, for instance, Singapore, which might suffer from imported inflation. These culminate in a wider socio-political impact: for instance, the hyperinflation in Weimar Germany in 1923 led to socio-political unrest and the collapse of the Weimar government.

Targeting Unemployment

Yet, inflation is not the main goal or the only focus of government policies. Another important goal of government can be to increase employment, or lower unemployment. Unemployment refers to the situation where people able and willing to work are unable to find jobs, and can be structural, demand-deficient, frictional, or seasonal. Being unemployed causes financial hardships for citizens, therefore governments have to ensure that there is job creation for citizens. For example, during 2008-2010, in the depths of the financial crisis and economic recession, there was massive unemployment in many developed economies, especially in the West. Governments can also tackle structural, frictional, and seasonal unemployment by focusing on these problems rather than concentrating their efforts on inflation.

In fact, reducing inflation sometimes leads to increased unemployment. This is because if the inflation comes from demand pressures, policies that lower AD might inadvertently cause demand-deficient unemployment. In a similar vein, focusing on solving unemployment might lead to higher inflation. This is because of government failure – governments do not always know where the AD and AS curves of the economy are, and their actions suffer from time lags and delays, due to imperfect information. If governments use demand side policies such as Keynesian fiscal policy, and the economy is near the full employment level, then an overshooting AD might lead to inflation. Therefore, there is a trade-off between inflation and unemployment.

Targeting Economic Growth

Another goal of government can be to raise economic growth, which leads to a rise of the standards of living in a country, which will generally make citizens better off. Economic growth is measured by percentage increases in real Gross Domestic Product (GDP), which measures the production of an economy. Generally, a higher real GDP per capita means a higher standard of living for the people of that country. There are two aspects to growth: actual growth measures the rate of change in the volume of output produced within the country in a year, and increases mean increased employment, another of the government’s goals. Potential growth is the percentage annual increase in the economy’s capacity to produce. Economic growth can be increased via increasing aggregate demand and increasing aggregate supply. Thus, the government may introduce demand management policies, such as monetary and fiscal policy, as well as supply-side policies in order to aid actual and potential economic growth respectively. Supply-side policies generally lower inflation by shifting LRAS to the right, and therefore it would seem that there is no trade-off.

However, increasing actual economic growth sometimes results in more inflation, because the AD shifts rightwards, and there might be a trade-off to be made between economic growth and a low rate of inflation; higher rates of economic growth are generally accompanied by higher rates of inflation, ceteris paribus.

Targeting the BOP

Another possible macroeconomic aim of government is to maintain a balance of payments (BOP) surplus. Generally, some governments like Singapore run BOP surpluses for most years, where export values exceed import values. For example, Asian countries such as China have been running huge BOP surpluses, vis-à-vis their trading counterparts, mainly western countries; they have been selling more exports than imports they buy, and this provides a net inflow of capital into their countries rather than an outflow.

However, running a current account surplus might lead to demand-pull inflation because exports (X) exceed imports (M), if the economy is already near or at the full employment level. Therefore there is a trade-off decision to be made between a current account surplus and demand-pull inflation.

Conclusions

In conclusion, one disagrees with the statement posed. All the macroeconomic aims of government are important and the government has to maintain a balancing act, considering various trade-offs. Also, governments may have to tackle different problems at different time periods, and thus inflation should not be the primary focus. In the final analysis, governments should use a combination of demand-management and supply-side policies to manage society’s macroeconomic aims, and not merely focus primarily on inflation, because it is one problem among many.

JC Economics Essay - Tutor's Comments: This is the second part to a question on inflation. There are many relevant real life examples in this essay, and this "A" grade essay also tackles a wide range of macroeconomic aims and  policies, which makes it a balanced, sound, and well-written Economics paper. In addition, the conclusion is considered, evaluative, and generally quite interesting to read. Overall, it is very well done! However, the usual question applies: if you were an Economics tutor, what would you do to make this Economics paper better? How would you improve on it? To take a specific case: if you were going to edit or correct the conclusion, what better conclusion, or what alternative conclusion to this Economics essay could you come up with? Think, think, think; thanks for reading and cheers!

Singapore's inflation: Explain, using relevant examples, the causes of inflation. [10] (Rephrased Economics Question)

(a) Singapore’s inflation remains high, at 5.7% in November 2011 from a year ago, because of higher rentals, private transport costs, and recreation costs.  Explain, using relevant examples, the causes of inflation. [10]

Inflation can be defined as a persistent and sustained increase in the general price level of an economy. Most commonly, the Consumer Price Index (CPI) is used as a barometer to measure inflation, measuring the price of a basket of commonly used goods and services; a persistent and sustained rise in the CPI can be considered inflation. The causes of inflation can be attributed to demand-pull and cost-push inflation, one affecting the aggregate demand (AD) and the other the aggregate supply (AS) of the economy.

Demand-Pull Inflation

The AD-AS diagram below demonstrates demand-pull inflation.

AD comprises C + I + G + (X-M), which are consumer spending, investment spending, government spending, and net exports. In the diagram, if any of the components increases, AD shifts rightwards to AD’ and then AD’’, causing the general price level to rise over a period of time, and inflation results, if the economy is near or at the full employment level.

On the consumption side, for instance, if consumers spend more because of low interest rates encouraging borrowing for consumption, for example on recreational activities, then AD will shift to the right, thus contributing to demand-pull inflation. If firms feel positive about the future economic outlook, and invest more, then AD will also shift to the right. If governments spend more on the military or police forces, or pursue a Keynesian fiscal policy of government spending, then AD will shift to the right, thus contributing to demand-pull inflation. If there is an export boom for local products exported overseas, or there is a softening of local demand for imported goods from overseas, then AD will also shift to the right. Hence, it is clear that excessive C, I, G, or increasing X with decreasing M, will lead to demand-pull inflation if the economy is near or at the full employment level.

Cost-Push Inflation

On the other hand, there is cost-push inflation as well, where AS moves upwards from AS’ to AS’’ and to AS”’. This is demonstrated in the diagram below:

This is mainly due to rising costs, and since the aggregate supply of goods and services is made up of various inputs, increases in the costs of the various factors of production lead to inflation. The supply of goods and services result from the factors of production of labour, capital, land, and entrepreneurship.

There are internal cost-push factors: rising wages or the rising power of trade unions demanding higher salaries, rising capital costs, and increasing scarcity of land and various input resources make cost-push inflation a pertinent possibility. For instance, demands for higher wages can lead to a wage cost spiral, which will raise the general price level. Higher capital costs will lead to a higher production cost for firms that produce capital-intensive goods as well. Increases in the levels of rentals in Singapore, for instance, will also lead to cost-push inflation.

There are also external cost-push factors. Exchange rates and the foreign sector can also lead to inflation if many goods produced use foreign inputs; hence there might be imported price-push causing cost-push inflation as well. In Singapore’s case, goods are usually produced using inputs from other countries due to our lack of natural resources; if those resources become more expensive overseas or if the Singapore dollar depreciates vis-à-vis those other countries’ currencies, then imported inflation will result.

Thus, inflation can be caused by demand-pull factors, cost-push factors, or a combination of both. 

JC Economics Essays: Tutor's Comments - This is a very well written examination piece, but right off the bat one possible improvement to this Economics essay is that it could do a lot better with more specific contextual examples. It does have examples, yes, and there are indeed some specifics inside this essay paper. However, it could have more specific examples. For instance, increases in the levels of rentals in Singapore could be enhanced with the use of industrial/ residential/ properties/ or businesses such as REITS, etc, etc. The usual tutor's comments also apply here: think of the other ways in which you could improve this essay. If you  were an Economics tutor marking this Economics paper, what would you comment on and why? Note that there is no need here for an evaluative conclusion simply because this question is only worth 10 marks, and it is only the 15 mark and 25 mark questions that require a proper evaluation with justification and evaluative comments and professional opinions. 

Discuss the effectiveness of government policies that could be used to tackle China’s inflation. [25] (rephrased Economics question)

“In 2003, China achieved an impressive growth rate of about 9%. Domestic consumption and investment formed the dominant source of her growth, and her inflation rate was above 5%. The economy was overheated.”

Adapted from The Straits Times, 2004

Discuss the effectiveness of government policies that could be used to deal with China’s ‘overheated economy’. [25]

Introduction

China is facing massive demand-pull inflation because of her rapid actual economic growth in recent years. Inflation can be defined as a persistent and sustained increase in the general price level, and can be classified as demand-pull or cost-push. In the context of China, because domestic consumption and investment forms the dominant source of China’s actual economic growth, the likely cause of China’s “overheated economy” is demand-pull inflation, which has to be countered using either demand-management or supply-side policies, or a combination of such measures by the Chinese government. This paper discusses contractionary demand-management policies, such as fiscal and monetary policies, and supply-side policies, in China’s context, and discusses the effectiveness of the suggested policies.

Demand-Pull Inflation

Insert Economics diagram here. What Economics diagram should go here?

In the diagram above, it is clear that increases in consumption (C) and investment (I) have led aggregate demand (AD) to shift to the right, which constitutes in this case actual economic growth, and thus inflation has resulted because the economy is near the full employment level. With a burgeoning middle class in China wanting to spend on consumer goods and other luxuries, and with domestic and foreign firms wanting to capitalise on the rising middle class in China, there has been a huge increase in AD. These collectively lead to demand-pull inflation because AD = C + I + G + (X-M), and therefore there is a need for the Chinese government to utilise either contractionary demand-management policies or increase the AS through supply-side policies.

Effectiveness of Government Policies

In the short run, contractionary demand management policies such as fiscal policy, monetary policy, or exchange rate policy can be used, to shift AD to the left and thus reduce inflationary pressures. In the longer term, supply-side policies can be used to increase the AS and thus reduce inflationary pressures.

What is the effectiveness of demand-side policies in China’s context? First and foremost, it is clear that any contractionary demand-side policy will reduce AD and tackle the problem directly. For instance, fiscal policy dictates that government spending should be reduced or taxes raised, and this would shift AD to the left, ameliorating inflationary pressures. Monetary policy used in this context would raise interest rates, reducing C and I because borrowing costs have increased, and therefore AD would also shift to the left. Appreciating the currency or revaluing the country’s currency would make exports look relatively expensive whilst imports look relatively cheaper, thus shifting AD to the left as well, directly addressing demand-pull inflation. In China’s case, a combination of fiscal policy and revaluation would make sense by reducing AD, directly addressing the issue.

What is the effectiveness of supply-side policies in China’s context? There are many supply-side measures that can be taken, for instance improving the efficiency of the labour market, via reducing frictional unemployment; increasing human capital training and development via training, retraining, and upgrading; and increasing labour productivity through capital and technological increases. These measures would be effective in the long run when AS shifts to the right and thus reduces the general price level in the intermediate and long term.

Ineffectiveness of Government Policies

On the other hand, the Chinese government has to be aware of possible limitations of such policies. First, contractionary fiscal policy might lead to unemployment and political problems if Chinese State Owned Enterprises laid off staff or if military spending were to be cut. Rising income taxes could hinder productivity and labour incentives because people might not work as hard. Corporate taxes, when raised, might affect the profitability of firms. These might lead to unemployment or lower actual economic growth.

Secondly, monetary policy could be highly ineffective in China’s case. This could be due to a variety of reasons. First, if business confidence is high, increasing interest rates would not dampen consumption and investment much. Secondly, China operates a fixed exchange rate and therefore the economic “trilemma” should apply to China. According to theory, a country cannot have free flowing capital, a fixed exchange rate, and yet pursue monetary policy using interest rates, because of the impossible economic “trilemma”. Thus, it is more likely that China uses exchange rate policy rather than depending mainly on interest rates.

Thirdly, supply-side policies operate in the long run but inflation affects China now. Furthermore, supply-side policies operate indirectly rather than tackling the root of the problem which is demand-pull inflation, which affects AD. Also, the Chinese government would have to invest in costly, expensive, and difficult long-term training, retraining, and upgrading for the workforce, and all this spending would have opportunity costs in terms of healthcare, defence, and education.

Conclusions

In conclusion, the Chinese government can use fiscal, monetary, or exchange rate policies in conjunction with longer term supply-side policies to tackle demand-pull inflation. However, multiple management policies would probably have to be implemented in order to successfully counteract the “overheated economy”. Also, there are trade-offs in that an excessive handling of inflation could lead to unemployment and slower actual economic growth, and governments should be aware of the trade-offs and their implications.

JC Economics Essays – Tutor's Commentary: The above Economics essay is on the interesting and current topic of inflation in China and government macroeconomic policies that could tackle this inflation. Instead of me telling you the grade that this paper would get – instead, let’s do another thinking exercise. Put yourself into the role of an Economics examiner looking at this piece of work. Once again, think about how your Economics tutors in Junior College, or university, for that matter, would rate this essay. Try to put yourself into your Economics tutor’s shoes. What would he or she say, and why? Also, try another exercise: try to draw out the diagram that would have been in this post if I had been less of a luddite and more of a techie. What would the diagram be, and why? Hint: you might want to use an AD-AS diagram - how would it look like? Thanks for reading and cheers.