2022 SH2 H2 Prelim EQ4 (Suggested answer).docx

4 The Bank of Korea slashed its benchmark interest rate to a record low of 0.75 per centin an emergency move following similar actions by the Federal Reserve and othercentral banks to combat economic damage from the coronavirus outbreak. Source: The Straits Times, 16 March 2020(a) Explain the factors that affect Singapore’s choice of exchange ratepolicyasitsmainpolicy to achieve internal stability in the economy.[10](b) Discuss whether a fall in world interest rates would have a positive impact on theSingapore’s economy. [15] Part (a)Introduction● State that internal stability in an economy refers to the achievement of macroeconomic goalsincluding price stability, low unemployment and economic growth.● ThefactorsthataffectSingapore’schoiceofexchangeratepolicyisdependentontheexport-orientedandimport reliant natureof Singapore’s economy as well as thelimitations of other macroeconomicpolicies leading to the choice of exchange rate policy instead as the main policy. Body● For a small and open economy such as Singapore, it is an economy that is export-ledandimportreliant and thus the root cause of its macroeconomic problems are related to trade. 1. Import-reliant Nature of Singapore Economy● Given that Singapore has limited resources and thus is import-reliant, a root cause of inflationaryconcerns in the economy is high imported cost of production.● Given that imported cost of production is a root causeof achievingpricestability inSingapore, theuseofappreciatingexchangeratewill beabletoeffectivelyachieveasuccessful economyintermsofprice stability.● Withanappreciationof exchangerate, priceof importedinput will becheaper indomesticcurrency.This helps toreducedimportedcostofproductioninSingapore,thuscausinganincreaseinhershortrun aggregate supply (SRAS).

Figure 1:Impact of Appreciation of Exchange rate on Import Price-Push Inflation2. Export-Oriented Nature of Singapore Economy● Given that Singapore is a small and open economy andthus export-led, aroot causeof economicrecessionandthus loweconomic growthis duetodepressednetexportrevenue.Thus,depreciatingexchange rate policy can help to address this.● Withadepreciationof exchangerate, priceof exports arecheaper inforeigncurrenciesandpriceofimports are more expensive in domestic currency. Given that Marshall Lerner condition, which is|PEDX + PEDM| > 1, will hold in Singapore context, adepreciationof exchangeratewill causeanincrease in net export revenue in Singapore.● The increase in net export revenue thus leads to an increaseinaggregatedemand(AD) andthusmorethanproportionateincreaseinnational incomeviathemultiplierprocess.Thus,actual economicgrowth is effectively achieved. 3. Limitation of Monetary Policy in Singapore● Duetopolicy trilemma, Singaporehastochoosetwobetweenthethreeoptions,namelyopencapitalflow, control of exchange rate or control of interest rate.● GiventhelimitationofmonetarypolicyinSingapore,excha