ACJC H2 Prelim 2024 P2 EQ4 Solutions

4(a) Explaintworeasonswhychangingtheexchangeratecanbemoreeffectivethanchangingthegovernment spendingtoaddresshighinflationinSingapore. [10] QuestionAnalysis Commandword “Explain”● Start: Appreciateexchangerate● End: how the GPL can be reduced via the fall in AD or theincreaseinSRAS● Noevaluationneeded Concept ● Highinflationsustainedincrease(at afast rate) inGPL● Monetarypolicy–exchangerate● Characteristicsof Singapore–small andopeneconomy Context Singapore Notetostudents: To scoreanalyticallyfor thisquestion, youarerequiredtoexplainthekeycharacteristicsofSingapore and explain how the monetary policy tool of exchange rate is much moreeffective to address inflation in Singapore. This means that you are to link to how thechanges in AD/ ASdue to appreciation of SGDcan help to reduceGPL. ThefocusisonreductioninGPL, rather thantheimpact onRNO/ RNY. Requirement 1:Contractionarymonetarypolicyintermsof appreciatingtheSingaporedollar (SGD) ismoreeffective than reducing government spending to overcome high inflation in Singaporebecauseit reducesimportedcost-pushinflation. Given Singapore's limited natural resources, it relies heavily on imported factors ofproduction. This implies that rising prices of imports is one of the largest causes ofinflationinSingapore. Explainhowanappreciationof SGDcanhelpwithimportedinflation:Appreciating the SGD reduces the price of imports in local currency SGD, ceteris paribus.This lowers the unit cost of productioninSingapore, increasingthewillingnessandabilityof firmstoproduce, increasingtheSRAS(fromSRAS0toSRAS1).

Assuming that theeconomyisoperatingbelowthefull employment output, firmspassonthecost savings down to consumers in termsof lower prices, causingGPLtofall fromPotoP1.Thisovercomesimportedcost pushinflation. (For analytical reasoning – students are encouraged to provide some reasoning whyexchange rate is better than changing govt spending). Reducing government spending hasno direct effect on controlling the price of imported resources since it involves changingthegovernment spending and direct tax rates, hence cannot overcome cost-push importedinflation, whichisextremelysignificant for Singapore. Requirement 2:Contractionarymonetarypolicyintermsof appreciatingtheSingaporedollar (SGD) ismoreeffective than reducing government spending to overcome high demand-pull inflation inSingaporebecauseit targetsthebiggest component of AD–export revenue. Since Singapore has a small domestic population, it is heavily reliant on the exportrevenue as its growth engine. This means that thecomponent of X-revenuetakesupthelargest proportion of its GDP. In comparison, its domestic C, I and G are relativelysmaller as a proportion of its GDP. While reducing government spendingwouldallowADtofall, it will not beassignificant asreducingexport revenue(X). Explainhowanappreciationcanhelpwithdemand-pull inflation:In the short term, an appreciation causes the price of Singapore's exports to be moreexpensive in terms of foreign currency. This cau