(a) Explain why low inflation is an
important macroeconomic aim of the Singapore
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!
