ACJC H1 ECONS P1 Qn4

4 (a) Explain the main causes of high inflation rates in Singapore. [10] (b) Discuss whether fiscal policy is the best policy for the Singapore government to achieve low and stable inflation rates. [15] a) Explain the main causes of high inflation rates in Singapore. [10] Suggested Approach Introduction  Define Inflation and identify the types of inflation – cost-push and demand-pull  Explain causes of cost -push and demand -pull inflation in Singapore which could be due to both domestic and external factors.  Context of Singapore: o Prone to demand -pull inflation as the economy is operating close to full employment. o As Singapore is a small open economy, external demand is likely to be larger than domestic demand, so demand-pull inflation is more likely to be externally driven rather than domestically driven. o With no natural resources and a limited land area, Singapore is highly reliant on imports of food and fuel, so cost push pressures are more likely to come with higher prices of such goods. o In general, given Singapore's high dependence on imports of food and fuel, Singapore is arguably more susceptible to cost -push inflation rather than demand-pull inflation Body (1) Demand-pull inflation Causes of demand-pull inflation Rising exports due to growing affluence of trading partners  In an export-oriented economy like Singapore, demand pull inflation is very likely due to strong external demand. This could be due to rising global growth or high global expectations and consumer confidence in the global market. High global growth  higher income and hence stronger purchasing power. Also boost business confidence boost export revenue and foreign investments into the country  drive up AD and hence GPL. AS P1 P2 P3 AD1 AD2 AD3 Q1 Q2 Real Output General price level

Government budget deficit (implies expansionary fiscal policy) i.e. the government’s increasing its spending and imposing tax cuts and subsidies, perhaps to stimulate the economy during economic slowdown or to achieve higher economic growth  Expansionary DD-management policies to increase growth will lead to inflation in the face of structu ral rigidities in the country . When direct taxes are reduced, consumers have more disposable income , causing consumer expenditure to increase. Lower corporate taxes will attract m ore investments, thus the increase in consumer expenditure and investment  AD rises, hence this will lead to higher general price levels. Thus, there is a rise in aggregate demand shown by a rightward shift of AD curve from AD 1 to AD 2. Assuming Singapore is operating near full employment, there will be a shortage of final goods and services which exerts upward pressure on GPL. GPL continues to rise until shortage is eliminated. The persistent increase in the general price level services from P 0 to P1 depicts demand-pull inflation. (2) Cost-push inflation Causes of cost-push inflation Tight domestic labour market  Singapore is facing ageing population and falling fertility rates which has led to falling labour force participation. To supplement labour shortages, Singapore has been relying on foreign workers especially for the low -end industries. However, the government has raised foreign worker levies and reduced foreign worker quotas in recent years as one of its productivity-raising strategies.  Since productivity -raising measures take several years to bring about an overall reduction in production cost, competition for scarce workers in the tight labour market has caused wages and labour costs to rise. Rising unit l abour cost in recent years has been caused by wage levels rising more than productivity. Productivity level in Singapore in general has been stagnant.  Diagram below illustrates the fall in SRAS (leftward shift) due to the rise in wages. As a result, GPL has increased from P1 to P2 due to businesses passing on cost pressures to consumers in order to protect profit margins. General Price Level Real National Output AS0 AD P0 Y0 0 AS1 P1 Y1 Y2

Domestic government policies  Singapore’s rising labour costs are mainly due to government policies – higher levy on foreign workers and higher employers’ contribution to workers’ CPF accounts  E.g., Singapore tightened foreign worker policies in recent years  Increase in foreign worker levies + reduction in Dependency Ratio Ceiling (DRC)  higher cost of labour  higher COP  Singapore’s falling birth rate and increasing reliance on foreign workers  significant impact expected for increase in COP  passed on in the form of higher prices of g/s  increase GPL significantly  Heightened restrictions in entry requirement for forei gners  fall in SS of workers in Singapore  drive up wages  higher COP  passed on in the form of higher prices of g/s  increase GPL significantly (3) Imported inflation For countries with an open economy like Singapore, inflation is most likely due to external reasons, for example a sudden rise in the cost of crude oil or other imported commodities, foodstuffs and beverages.  The high inflation in Singapore in 2008 was ma inly due to rising oil and food prices, which are mainly imported. The oil and food prices caused global inflation  imported inflation in Singapore as most of the imported goods prices rises due to the rising inflation in the countries they were produced.  Depreciation of currency  rising import prices in domestic currency  in an open economy heavily dependent on imports, leads to an increase in the prices of imported products such as essential raw materials, components and finished products  rising inflation Conclusion The causes of inflation in a country may come from both the demand and the supply-side of an economy and may even arise from internal and external events. The main causes of inflation in different countries may differ from one another d epending on factors such as the openness of the economy, the size of its domestic market, the level of dependence on external market and domestic market and even the objectives of the government. Level Descriptors for Essay Question 4 (a) Marks L3  Conceptually accurate and well -developed explanation on at least 2 causes, how demand and supply -side factors lead to rising inflation in Singapore.  Causes encompasses both domestic and external causes and should consider both demand-pull and cost-push inflation.  Good use and explanation of AD/AS diagrams as conceptual framework  Well-contextualised to Singapore 8-10 L2  Well-developed analysis of factors contributing to either demand-pull or cost-push inflation OR  Undeveloped analysis of factors contributing to both demand -pull and cost-push inflation  Very limited reference to Singapore context 5-7 L1  Major conceptual errors in analysis  Absence of conceptual analysis 1-4

b) Discuss whether fiscal policy is the best policy for the Singapore government to achieve low and stable inflation rates. [15] Suggested Approach Candidates are required to explain how fiscal policy can help Singapore to achieve low and stable inflation rates in Singapore. Even though it can help to mitigate demand-pull inflation. It does not address various source of inflation in Singapore such as imported inflation and persistent labour shortages. Candidates are required to compare the policies in evaluating which is the best policy in achieving low and stable inflation rates in Singapore. Introduction  Objective of government: achieve low and stable inflation rates –inflation rates about 1-3%  Price stability is important to Singapore’s economy as it is the basis for maintaining export competitiveness and providing a positive business environment to achieve healthy and sustained