MJC_H2_ECONS_EQ4

2018 JC2 H2 Prelim Essay Q4 Discuss the extent to which trade-offs in macroeconomic objectives will arise when the Singapore government allows its currency to appreciate. [25] Suggested Answer: Introduction: The use of exchange rates is a significant tool to help Singapore achieve her economic goals. Through exchange rate policy, the Si ngapore government is able to control its inflation, which in turn will make her exports competitive and attract FDIs. Development 1: Explain the intended outcome of an appreciation of the SGD i.e. explain how appreciation works to lower inflation rate in SG In SG, a modest and gradual appreciation is used by the Monetary Authority of Singapore (MAS) to mitigate against imported inflation. Th is is important as Singapore has a high marginal propensity to import and a modest appreciation would thus place emphasis on the addressing of imported inflation first. To deal with rising prices from the global commodity markets, a stronger SGD will reduce the cost of imported raw materials that is expressed in terms of local currency, thus possibly offsetting the rise in price of these raw materials in foreign currency. This lowers the unit cost of production significantly and increases supply of goods and services. If many individual market supply curves increase, then SRAS increases from AS1 to AS2 as shown in Figure 1, causing GPL to fall, thus tackling the problem of imported cost-push inflation. In addition, the appreciation also causes imported final goods and services to be cheaper in terms of SGD, and also increases competitive pressure for domestic firms to keep prices low. These overall aim to lower domestic inflation rates in SG. The appreciation of the SGD can also help to curb demand-pull inflation. With an appreciation of the SGD, price of exports in foreign currency rises and price of imports in domestic currency (SGD) falls. Assuming PEDx>0 in SG’s case, there will be a fall in demand for exports, and hence export revenue measured in SGD. At the same time, since PEDm<1 for SG, the fall in prices lead to a less than proportionate increase in quantity demanded for imports, causing a fall in import expenditure. If the Marshall-Lerner condition holds, wher e (PEDx+PEDm)>1, this will decrease net Figure 1 Figure 2

export revenue (X-M) and aggregate demand (A D), ceteris paribus. Marshall-Lerner condition holds for Singapore because the demand for Singapore’s export is price elastic (i.e. PEDx>1) due to the wide availability of substitutes for Singapore’s exports. While this further helps to manage inflat ion through a lowering of the AD and hence GPL (lowering demand-pull inflation), it also in turn leads to lower real output. However, the appreciation of the SGD wi ll mean that export competitiveness is compromised. This is because Singapore’s exports, being expressed in SGD, will now require more foreign currency to be exchanged for them given the