Macro Economic Problems Policy Tutorial (2010)v6- For Students

ST ANDREW’S JUNIOR COLLEGE

H1 and H2 ECONOMICS (8819/9732)

Tutorial - Macroeconomic Policies

CASE STUDIES

Q1 2008 VJC Prelim H2 P1 Q2 Part (c) and (d): The “Stagflation” DiseaseQ2 2006 AJC Prelim H2 P2 Q2: The Economic Woes of East AsiaQ3 2008 NYJC Prelim H2 P1 Q2 Part (d): The Economies of China and India

ESSAYS

Q1 “For the past 8 years, Chinese yuan has maintained its fixed value against the US dollar. Of late, China has come under heavy pressure to revalue the yuan because the USA felt it was undervalued.”

Adapted from The Straits Times, Sept 2003

(a) What factors might have contributed to the undervaluation of yuan? [8]

(b) Discuss the likely consequences for China if yuan is allowed to float freely in the foreign exchange market. [17]

Q2 (b) Discuss whether fiscal policy is the most effective way for Singapore to sustain a successful economy. [13]

GCE “A” Level Exam, November 2007

Q3 (b) Discuss whether demand-side policies are the most appropriate way for Singapore to sustain a successful economy. [13]

SAJC BT2, 2008

Q4 “With asset prices falling in many key markets, soaring energy and commodity prices stoking inflation, and global growth on a downturn, the world faces some difficult policy choices”.

- IMF First Deputy Managing Director John Lipsky, 22nd July 2008

(a) Explain the macroeconomic impact of the above on Singapore. [12]

(b) Assess the policies that the Singapore government can adopt to reduce the harmful effects of these problems. [13]

SAJC Prelims, 2008

SAJC/2010/JC2/H1 and H2 1

Q5 In view of the internal and external challenges facing the Singapore economy, discuss whether the Singapore government has adopted the most appropriate economic policies to overcome these challenges. [25]

SAJC Mock Exams, 2008

Q6 Discuss how the characteristics of being ‘small’ and ‘open’ has influenced the policy options of the Singapore government. [25]

H2 P2, NJC Prelim, 2009

Suggested Activities

For Monetary Policy:http://www.frbsf.org/education/activities/chairman/index.html

The above website contains a series of good videos explaining monetary policy, the tools of monetary policy, and the history of monetary policy in the USA. It also has a simple game in which students can change the discount rate and see the effects on unemployment and inflation rates.

Please note that the above website is US-based and is based on the Federal Reserve system in the USA.


http://www.frbsf.org/education/activities/chairman/index.html

CASE STUDIES

Q1 2008 VJC Prelim H2 P1 Q2 Part (c) and (d): The “Stagflation” Disease

It's a toxic economic mix the nation hasn't seen in three decades: Prices are speeding upward at the fastest pace in a quarter century, even as the economy loses steam. Economists call the disease "stagflation," and they're worried it might be coming back.

The economy nearly stalled in the final three months of last year and probably is barely growing or even shrinking now. That's the "stagnation" part of the ailment. Typically, that slowdown should slow inflation as well -- the second part of the diagnosis -- but prices are still marching higher. Once the twin evils of stagflation take hold, it can be hard to break the grip. People cut back on their spending as they are stung by rising prices and shrinking wages. Businesses, also smacked by rising costs and declining demand from customers, clamp down on their hiring and capital investment.

Since last summer, the housing slump has worsened, credit problems have intensified and the job market has deteriorated. This combination of bad news has made people and businesses more cautious about spending and investing — further weakening the economy. To brace the teetering economy, the Federal Reserve Chairman Ben Bernanke and his colleagues have been reducing its interest rate since September 2007 with the biggest one-month reduction in a quarter-century in January of 1.25% points. However, to combat inflation, the Fed would be expected to boost rates instead.

"The Fed has its hands full. It is preoccupied with the economic slowdown at the front door, but inflation looks to be sneaking in the back door," said Greg McBride, senior financial analyst at Bankrate.com. "If that trend continues, the Fed would need to show the economy some tough love, meaning higher interest rates to keep inflation from getting out of hand." On the other hand, Brian Bethune, economist at Global Insight, said Bernanke can fight only one war at a time, and the more pressing issue right now is to shore up the ailing economy. "That's the war that needs to be fought. The war on inflation will have to come another day," Bethune said.

Maybe things won't be so bad. Federal Reserve vice chairman Donald Kohn said in a speech that he doesn't expect the recent elevated inflation readings to persist. People are weathering the economic storms. Earlier this month, nervous shoppers handed the nation's retailers their worst January in almost four decades. High oil and food prices, the toll of the housing bust, the credit crunch and a tougher job market all were to blame. Disappointing sales were widespread, hitting discounters like Wal-Mart Stores Inc. and upscale merchants like Nordstrom Inc. Sales of new homes fell in January for a third straight month. Orders to factories for big-ticket manufactured goods dropped in January by the largest amount in five months.

Wary employers eliminated jobs in January, the first nationwide loss of jobs in more than four years. With the economy on the edge of a recession -- if it hasn't toppled over already – the Fed for the near term is much more likely to keep lowering rates.SAJC/2010/JC2/H1 and H2 3

Bernanke said at some point this year, the Fed will need to “assess whether the stance of monetary policy is properly calibrated” to foster the Fed’s objectives of price stability “in an environment of downside risks to growth.” He was hopeful that previous rate reductions and the $168 billion economic aid plan of tax rebates for people and tax breaks for business would energize the economy in the second half of 2008.

Bernanke was asked when he thought the housing market might stabilize. It’s possible, he said, that by “later this year it will stop being such a big drag directly” on the economy. But home prices probably will decline into next year, he added. “It is very difficult to know, and we’ve been wrong before,” Bernanke said.

Even as the Fed tries to shore up the economy, it must remain mindful of inflationary pressures, Bernanke said. Oil prices, which have set records, briefly shot past $102 a barrel on Wednesday. Prices eased later but still remain close to $100 a barrel.

“Should high rates of overall inflation persist,” Bernanke said, “the possibility also exists that inflation expectations could become less well-anchored.” If people think inflation is escalating, they will act in ways that could make things even worse, a sort of self-fulfilling prophecy. Bernanke said that could complicate the Fed’s job of trying to nurture growth while also keeping inflation under control.

If oil prices continue to skyrocket this year, it would be “hard to maintain low inflation,” Bernanke acknowledged. Can a serious bout of stagflation be avoided? Many economists believe the Fed's aggressive rate cuts along with tax rebates for people and tax breaks for businesses will lift the economy in the second half of the year.

Adapted from: Bernanke signals yet another rate cut despite inflation worries, Fed chief focuses firmly on ailing economy, Associated Press, 27 Feb 2008; Worries grow for worse 'stagflation', Associated Press, 26 Feb 2008.


TABLE 1: Intended federal funds rate


Change Occurrence and Level (percent) Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2001 1.75

2002 1.25

2003 1.00

2004 1.25 1.50 1.75 2.00 2.25 2005 2.50 2.75 3.00 3.25 3.50 3.75 4.00 4.25 2006 4.50 4.75 5.00 5.25

2007 4.75 4.50 4.25

2008 3.00 2.25 2.00

TABLE 2: Index of Consumer Sentiment, Quarterly(Q) Year Q1 Q2 Q3 Q4 2001 92.3 91.0 88.6 85.1 2002 93.1 94.1 87.3 83.8 2003 80.0 89.3 89.3 92.0 2004 98.0 93.3 95.6 93.9 2005 94.1 90.2 87.5 82.4 2006 88.9 83.8 84.0 92.5 2007 92.2 86.9 85.7 77.5

Source: Reuters / University of Michigan Surveys of Consumers, www.sca.isr.umich.edu

(c) How effective is the lowering of interest rate in fighting recession? [8]

(d) As the economic advisor to the government, evaluate alternative policies to combat the “twin evils of stagflation”. [10]

With acknowledgements to the Economics Unit of Victoria Junior College

Q2 2006 AJC Prelim H2 P2 Q2: The Economic Woes of East Asia




With acknowledgements to the Economics Unit of Anderson Junior College


Q3 2008 NYJC Prelim H2 P1 Q2 Part (d): The Economies of China and India

Table 2: FDI Overview: India and China

Table 3: Average Annual Growth of Exports of Goods and Services, 1990-2004 (%)1990-2000 2000-2004

China 13.0 24.2India 12.3 12.0LMIC* 7.3 10.1World 7.0 5.0

* Low and medium income countries

Graph 1: GDP Growth Rates in China and India, 1998-2006

0

2

4

6

8

10

12

14

1998 1999 2000 2001 2002 2003 2004 2005 2006

Year

%

China

India

Extract 4: China versus India: FDI MagnetSAJC/2010/JC2/H1 and H2 10

India has emerged as the second hottest FDI destination of the world, next only to China base on the United Nations Conference on Trade and Development's (Unctad) World Investment Prospect for 2007- 09.

One of the key factors that favoured China as an FDI destination was the emerging need for "relocation of manufacturing operations" by multinationals to improve cost competitiveness. Foreign companies invest in China, produce goods at lower costs and re-export to their own countries to counter the growing price competition in their domestic markets. Also, China continues to provide favourable environments to attract FDI, joint ventures, and trade partners, with a lot of preferential treatment.

However, the FDI trend in the world is changing. With the focus turning to the services sector, especially IT, there is a big opportunity for India to attract more FDI. Nearly half of the country's growth is driven by the services sector, which needs huge investments to raise itself to global standards. Already, telecommunications and computer software have become the main sectors for FDI in the country. In 2003, about a fourth of the FDI approved was in these segments.

Adapted from Why China Wins Race in FDI. (http://www.thehindubusinessline.com) and United Nations Conference on Trade and Development's (Unctad) World Investment Prospects for 2007-09

Extract 5: China and India’s Demand for Oil China and India are largely responsible for the world’s skyrocketing oil prices. Their dazzling economic growth is increasing their consumption of fossil fuels considerably. The two countries are to be found on all the fronts of the new wars over black gold.

The past three years were marked by a steady rise in commodity prices, especially those of fossil fuels. The barrel of crude oil appreciated 40% between September 2004 and September 2006, when it was selling for US$65. The tensions surrounding these prices are maintained by several factors, such as the chaotic situation in the Middle East, political instability in Venezuela and Nigeria, under-investment in refining capacity, and even speculative anticipation. However, this oil crisis in the making is explained above all by China and India’s economic development. These two countries are responsible for more than a third of the increase in global consumption since 2000. Today, China and India, which are respectively the world’s second and sixth leading oil consuming countries, are in worrisome situations, because their dependence on oil imports continues to strengthen. China has been importing oil since 1993 and the share of its purchases abroad in total consumption has risen from 30% in 2000 to 50% today. The situation in India is just as worrying. Although this country continues to be very poor (its total fleet of automobiles is only one third of China’s), 70% of the oil that is used there comes from abroad. When it comes to the ranking of world oil importers, China comes third, after the United States and Japan, while India is already 9th in the list.

Oil prices still matter to the health of the world economy. Higher oil prices since 1999 contributed to the global economic downturn in 2000-2001 and are dampening the current cyclical upturn: world GDP growth may have been at least half a percentage point higher in the last two or three years had prices remained at mid-2001 levels.

Adapted from China and India: An all-out oil strategy. (Ellipses, 2006).


Extract 6: Challenges of ChangeThe emergence of China and India presents Asia with challenges as well as opportunities. It has intensified competition, and forced other countries to adapt to a radically changed situation. Countries with low wages and surplus labour, like Vietnam and Indonesia, feel the heat directly because they occupy the same niches in the international economy as China and India. Hence, Vietnam is accelerating its economic reforms, preparing to join the WTO, and pushing hard for growth and investments. Indonesia is setting up Special Economic Zones (SEZs) to create a more conducive investment environment, especially in the Riau islands near Singapore, where Singapore is able to work with Indonesia and help to promote the SEZs to investors.

Even more developed countries like Singapore feel similar pressures. In these countries, at the high end of the workforce, entrepreneurs and skilled professionals are benefiting from the many opportunities opening up all over Asia. But at the lower end, less skilled workers are seeing their wages stagnate, like less-skilled workers elsewhere. But the pressure extends well beyond the least skilled workers. China and India are moving up the value ladder, and growing their scientific and technological prowess. Chinese universities now lodge as many patents in China as American universities lodge in the US. India's outsourcing industry not only processes credit cards and airline reservations, but also interprets medical scans and researches legal precedents. The end result is an accelerating pace of change and a widening of income disparities. The countries are being forced to restructure and upgrade, or else be overtaken and hollowed out.

Speech By Mr Lee Hsien Loong,Prime Minister, at the Lloyd's City Dinner, 7 September 2006, 9.30 pm at the Merchant Taylors Hall, London

Questiond. As the economic advisor to the Singapore government, discuss the

policies you would recommend to ensure that the Singapore economy remains competitive. [8m]

With acknowledgements to the Economics Unit of Nanyang Junior College


Suggested Answers:

CASE STUDIES

CSQ1: 2008 VJC Prelim H2 P1 Q2 Part (c) and (d): The “Stagflation” Disease

2c) How effective is the lowering of interest rate in fighting recession? [8]

Big Ideas: stagflation, lower interest rate, recession

Enduring Understanding:

With the aid of an AD/AS or Y-AE diagram, explain how a reduction in interest rate can reduce the opportunity cost of borrowing funds for consumption and investment, thereby boosting AD (and AS in the long run). With an increase in AD, the derived demand for factors of production will also increase, thereby raising employment or lowering the unemployment rate. An increase in AD will also lead to a multiplied increase in equilibrium level of national income via the multiplier process, thus stimulating economic growth and recovery. However, the effectiveness of an interest rate cut depends on how responsive are consumers and investors to an interest rate cut.

Essential Questions:

What is stagflation? Why is stagflation a disease? How can a cut in interest rate fight recession? How effective is an interest rate cut in fighting recession?

Suggested Answer Scheme:

- Define recession:Fall in real GDP (negative GDP growth rates) for two consecutive quarters – ailing economy due to declining demand from customers and cutting down on capital investment (mentioned in Extract 1)

- How lowering interest rates could help?Deliberate attempt by Fed to lower interest rate will help to boost AD -Explain the working of transmission mechanism, i.e. lowering interest rate to increase C and I, hence increasing AD. Mention that if successful, multiplier effect would kick in and economy will experience multiplied increase in real NY.

- AD/AS or Y-AE diagram can be used to illustrate workings of the measure.

- How effective for US?Dependent on how interest-responsive consumers and investors are to the interest rate cut.


Not interest-responsive after all: sluggish economy consumers and investors more cautious about spending and investing. More US jobs continue to be lost; less income earned further aggravate the fall in C. Hence despite the interest rate cut, it might not be able to spur AD.

- Conclude. Interest-rate cuts are necessary to boost the economy but given the poor consumer and business outlook in the US, effectiveness of the policy would be tested.

Level Descriptor

L3Analyse the effectiveness of the policy in the context of US economic conditions.

L2Explaining clearly how interest rate cut is able to increase AD through the policy mechanism.

L1 Recognising the works of interest rate cut to boost AD.

2d) As the economic advisor to the government, evaluate alternative policies to combat the “twin evils of stagflation”. [10]

Big Idea: demand-side and supply-side policies, twin evils of stagflation

Enduring Understanding: Demand-side policies such as expansionary fiscal policy may stimulate economic growth but worsen demand-pull inflation. In the long run, the best policy is to implement LR supply side polices (focused on increasing productivity or productive capacity) that could increase economic growth and lower inflationary pressures at the same time – sustainable non-inflationary economic growth.

Essential Questions: What are the twin evils of stagflation? What are the alternative policies (other than interest rate cuts) to combat the

twin evils of stagflation? What are the strengths and limitations to alternative policies? Which alternative policy or policies can be most effective or appropriate?

Suggested Answer Scheme:Explain what is meant by “twin evils” = Stagnant or negative growth and Inflation.

Evaluate the use of any SR policy to stimulate growthE.g. The government can use expansionary fiscal policy to increase AD and stimulate growth through the multiplier. (From Extract 1, $168 billion economic aid plan of tax rebates for people and tax breaks for businesses.)

Limitations and conflicts:SAJC/2010/JC2/H1 and H2 14

- Pessimistic outlook might limit the effectiveness (consumer sentiment falling)

- Even if the policy is effective, considering the situation of the economy, the increase in AD will lead to greater inflationary pressures. Another policy must be implemented to reduce the impact of inflation (Tinbergen’s Principle).

Explain how another SR policy should be used to combat inflation specifically. E.g. As the inflation is partly due to more expensive imported raw materials, an exchange rate policy that strengthens the USD can be adopted.

Stronger USD imported raw materials become cheaper lower COP for US producers lower prices of final goods and services charged to US consumers lower inflationary pressure

Stronger USD reduces export price competitiveness and encourages imports of goods and services reduces excessive increase in AD reduces demand-pull inflation

*Any analysis on only SR supply side policies will also be accepted if students highlight that the supply shocks are the main cause of the problems faced in the economy.

In the long run, the best policy is to implement LR supply side polices (focused on increasing productivity or productive capacity) that could increase economic growth and lower inflationary pressures at the same time.

Assess effectiveness/Limitations of possible LR supply side policies- Efforts to increase investments to boost productive capacity may not

materialise if investors’ expectations are pessimistic (nervous shoppers handed the nation's retailers their worst January in almost four decades).

- The problem comes from, to a large extent, the high prices of raw materials that might be limited in supply thus any increase in production could be minimal and the demand would still outweigh the supply.

← Inflation that is imported might not be corrected with SS-side policies.

ConclusionIn the SR with only one policy instrument, Tinbergen's Principle dictates that the policy can only achieve one goal thus a minimum of 2 policies should be implemented in the SR to combat the “twin evils” as conflicts will arise.

Level Descriptors

L1 Shows some knowledge but incomplete explanation of alternative policies.

L2Explanation of 2 alternative policies and some attempt to discuss their limitations If detailed analysis of only 1 policy (cap at 5 marks)


L3Use of economic analysis to explain why at least 2 policies are needed with reference to the context in the SR.

E1 For an evaluation with no substantiation.

E2For an evaluation that clearly justifies why at least 2 policies need to be used to solve the problem.

With acknowledgements to the Economics Unit of Victoria Junior College

CSQ2 2006 AJC Prelim H2 P2 Q2: The Economic Woes of East Asia

a. Explain what is meant by structural unemployment and with reference to SAJC/2010/JC2/H1 and H2 16

Extract 1, explain why Singapore is facing the problem of structural unemployment. [6]

What is structural unemployment?- Unemployment due to changes in the structure of the economy, usually

from focusing on lower-value to higher-value production process.- The mismatch of skills during this change of focus leads to the

unemployment of labour.

Why is Sg facing the problem?- Investors attracted to lower-cost countries such as China (low wages), i.e.

Sg no longer has CA in labour-intensive industries, e.g. relocation of Maxtor- Focusing on new, higher-value added industries which require specialised

skills. Workers who were retrenched cannot meet the demand of the new jobs, hence, structurally unemployed.

b. How far does the data suggest that inflation in East Asia will be largely due to rising oil prices? [6]

Rising oil prices cost-push inflation, as oil remains key input in many sectors of the economy. Could assume East Asia to include SEA; else very limited evidence to offer as answers.

Evidence of rising oil prices leading to inflation- Expectation of inflation should there be increase in oil price (Table 1).

Quote figures to support answer.- Subsidies and price controls needed to cushion impact also shows that

inflation caused by rising oil prices. (Extract 2)

Evidence of inflation not due to rising oil prices- Though expected inflation in Sg was 2.5% had there been rise in oil prices,

but inflation was only 0.5%. Either there had not been a rise in oil prices or projection methodology was inaccurate. Also, there could be a time lag which caused the delay in increase in prices reflected.

- A fall in supply of basic food crop such as rice due to the prolonged drought faced by countries such as Thailand may also have contributed to the increase in prices (Thailand being the world’s largest rice exporter).

Conclusion- While rise in oil prices may be the key factor leading to inflation in East Asia,

it is not likely to be the sole contributor.

c. Discuss the view that higher oil prices is the main cause of slow growth in Singapore and other parts of East Asia. [8]


Higher oil prices is the main cause of slow growth- Higher COP leading to upward shift of AS- Higher import price – imported inflation, as Sg relies heavily on imports from

other regional countries who suffered from the effects of higher oil prices as well.

- With fall in AS and lower AD brings slower economic growth! (As projected of the fall in GDP growth in Table 1 when oil prices rise by $20/bbl)

Higher oil prices NOT the main cause of slow growth- Fuel consumption is low in Sg, hence, impact of higher oil price should not

be significant. In addition, higher oil price should bring higher oil export revenue to Singapore – should boost our economic growth. (Extract 3)

- Other factors may be the contributor of slow growth (Extract 2)o weak global demand for high-tech products (affects more developed

East Asia economies)o slowdown in major industrialised economies (affects most East Asia

economies) ando tightening of monetary policies in US (affects most East Asia

economies)

Evaluation- Rise in oil price may affect East Asia economies to different extent,

depending on many factors (e.g. reliance on oil imports? Reliance on exports of high-tech products? reliance on major industrialised economies for trade?).

Conclusion- Higher oil prices did affect growth in East Asia economies but policy-makers

would need to recognise the other sources which drag the progress of economies in recent years.

d. ‘The key challenge for East Asia is to calibrate fiscal, monetary and exchange rate policies while at the same time pursuing structural reforms to strengthen domestic demand.’


Consider the policy options the Singapore government could adopt to reduce the effects of rising unemployment and rising oil prices.

[10]

- Supply-side policies o retraining to level up the skills of retrenched workers so as to provide a

better match between skills and job requirement (Extract 1)o Usually takes a long time to retrain workers; may face resistance from

workers who are sole bread-winners of family or who are senior in age.o Funds needed to train workers – incur opportunity costs (could have

been spent on other uses)

- Wage Policieso To reduce wage increases or even recommend wage freeze/cuts so as

to retain competitiveness against other countries.o This would also reduce wage-price spiral so as to curb excessive

wage-push inflationo There is a limit to which wages could be cut to maintain certain

minimum SOL. Families who rely on CPF monies to service their housing loans may face difficulties when CPF contribution falls due to wage cut.

- Fiscal policieso Provision of rebates (e.g. rental, utilities, etc) to help reduce COP at

least during this period of high oil prices to reduce closing down of firms.

o Funds required (opportunity costs incurred). Also, this is just a temporary measure – artificially lowering of COP may not be wise. Need to revamp production technique to reap truly lower COP so as to remain competitive

.o Bring forward government spending such as improvements to

infrastructure and housing (e.g. more roads, highways, SERS, etc) so as to create jobs.

o Makes sense as cost of projects tend to be lower during downturn.o However, jobs created may not be able to absorb all retrenched

workers. Certain amount of retraining still needs to be carried out.

- ERPo Stronger S$ would help to reduce the impact of higher oil prices (as

inputs) as well as reduce impact of higher COL (when Singapore faces imported inflation when importing finished g/s from countries which suffered from higher oil prices).

o Effective as it brings down cost of imports for all sectors in the economy. However, it also means that export competitiveness is reduced. Need to explore means to reduce COP from other sources in order to maintain export competitiveness.

L1(1 – 3)

Policies targeted at only one problem – either unemployment or rising oil prices.


L2(4 – 6)

Policies targeted at both problems, use of analytical approach to explain how policies work.

L3(7 – 10)

Answers are based on Singapore’s context. Recognises trade-offs and limitations of policies and uses analysis to show a reasoned conclusion.

CSQ3 2008 NYJC Prelim H2 P1 Q2 Part (d): The Economies of China and India

d. As the economic advisor to the Singapore government, discuss the policies you would recommend to ensure that the Singapore economy remains competitive. [8]

Big Idea: Competitive, demand-side and supply-side policies

Enduring Understanding: Most importantly, Singapore needs to constantly restructure and upgrade, or else be overtaken and hollowed out. Polices that should be adopted include long run supply side policies.

Essential Questions: What is the notion of Singapore being internationally

competitive? What policies can be recommended for Singapore to be competitive? What are the strengths and limitations of each policy? Which alternate policy or policies can be most effective or appropriate?

FP (3 marks)o Government spendings (G) on R&D, training, education and skills

upgrading courses to make exports more competitive in terms of quality and price.

o Corp tax and income tax reduction to attract FDIs and foreign talents

so that there can be exchanges of skills, technologies and expertise. More efficient way of production.

o Provide incentives and upgrade infrastructure to further attract FDIs

that help to move Singapore up trade ladder e.g.: Biomedical firms, nanotechnology firms etc.

Evaluation (2 marks): Takes a long time to take effect. Workers may not be willing to take up training especially the older workers. In the SR,


expansionary FP will create inflation pressure.

• An appreciating exchange rate (1 mark)o This is to help make important raw materials such as oil to be cheaper

in midst of rising price. Thus, cost of production low can be kept low. This helps to keep our exports competitive.

o Also, with an appreciation, imports of final goods and services will

become more affordable and cost of living kept low. Evaluate: There must be enough foreign reserves for Singapore to sell and buy SGD (1 mark)

• Sign FTAs with China and India and seek joint-ventures (e.g.: Industrial Parks). Evaluation: Agreement may be hindered by bureaucracy (1 mark)

With acknowledgements to the Economics Unit of Nanyang Junior College


ESSAYSEssay Question 1

Q1 “For the past 8 years, Chinese yuan has maintained its fixed value against the US dollar. Of late, China has come under heavy pressure to revalue the yuan because the USA felt it was undervalued.”

Adapted from The Straits Times, Sept 2003

(a) What factors might have contributed to the undervaluation of yuan? [8]

(b) Discuss the likely consequences for China if yuan is allowed to float freely in the foreign exchange market. [17]




Essay Question 2

(b) Discuss whether fiscal policy is the most effective way for Singapore to sustain a successful economy. [13]

GCE “A” Level Exam, November 2007

Big Ideas: Fiscal policy, successful economy

Enduring Understanding: Given its limited effectiveness, including Singapore’s substantial savings and import leakages, fiscal policy may not always be the most effective way to sustain a successful economy under all circumstances. Nevertheless, as a catalytic tool and for its supply-side effects, it remains a powerful instrument and effective way for Singapore to sustain a successful economy. However, fiscal policy needs to be supplemented by a comprehensive set of complementary economic policies for an economy to achieve its macroeconomic aims and translate ultimately into a higher standard of living for its people.

Essential questions:

What is fiscal policy? How does fiscal policy work? How effective is the use of fiscal policy in Singapore? – limited by its high

leakage ratio What is the evaluation of fiscal policy?

Suggested answer:

Fiscal policy is one of the government macroeconomic policies used to affect aggregate demand by altering the balance between government expenditure and (tax and non-tax) revenue. In times of economic slowdown, sluggish growth or recession, it is widely expected that governments adopt an expansionary fiscal policy by reducing taxes and/or increasing government expenditure to boost aggregate demand and employment and via the multiplier process, cause a multiplied increase in equilibrium level of national income, and hence economic growth. Conversely, in times of overheating, the government may adopt a contractionary fiscal stance by reducing government expenditure and raising taxes, to slow down runaway growth and dampen inflation.

Before evaluating the effectiveness of fiscal policy, it is prudent to interpret the meaning of a successful economy first. A successful economy is one which not only experiences strong and sustainable growth, low inflation, low unemployment rates and a favourable balance of payments position, it also enjoys economic stability and attains its microeconomic objectives of social equity, provision of public goods and low or reduced negative externalities. Ultimately, for an economy to be truly successful, the attainment of micro and macroeconomic objectives should translate into a higher (material and non-material) standard of living for the people.


Antithesis: Fiscal policy is NOT the most effective way

On one hand, fiscal policy is not the most effective way of sustaining a successful economy. This is because it has a number of inherent limitations. They include the inflexibility of government expenditure, inaccurate projections or forecasts, inappropriate methods of financing government expenditure, policy conflicts, recognition, policy formulation and implementation time lags, fiscal drag caused by automatic fiscal stabilisers, unpredictable government expenditure, unpredictable effects of tax changes on consumption and investment and crowding out effects.

Moreover, the value of the fiscal multiplier is limited by the fact that Singapore is a small, open and resource-scarce economy whereby the total value of foreign trade is approximately 5 times that of its Gross Domestic Product (GDP) in 2007. The implication of this is that the economy has a high import leakage ratio. It was reported that for every S$1 spent in Singapore, 60 cents gets leaked out (form the domestic circular flow of income) in the form of import.

Furthermore, Singapore’s compulsory savings scheme in the form of employers’ and employees’ contribution to the Central Provident Fund (CPF) means that Singapore’s savings ratio is higher than many other countries. Given the high value of Singapore’s marginal propensity to save and to import, the value of the Keynesian fiscal multiplier is reduced, thus limiting the effectiveness of fiscal policy.

In addition, fiscal policy cannot do what other macroeconomic policies can achieve, such as moderating imported inflation (via exchange rate policy of S$ appreciation) or moderate price and income (related to supply-side policies).

Thesis: Fiscal policy is the most effective way

On the other hand, fiscal policy can be the most effective way of sustaining a successful economy, especially as a counter-cyclical tool to moderate excessive swings in economic cycles. As mentioned above, in times of economic slowdown, sluggish growth or recession, governments are expected by their electorates to stimulate economic recovery through fiscal pump-priming.

Singapore has done this a number of times in its modern economic history. When the economy experienced recessions in 1985-86, Asian Financial Crisis in 1997-98 and SARS in 2003, the government implemented fiscal measures designed to increase government spending, cut business costs through tax rebates and reduce business levies and statutory charges. In the current recession of 2009, the government designed a budget that will help ease business costs. The government accelerated the implemented of public infrastructure projects such as the building of new Housing and Development Board (HDB) towns in the past, MRT circle lines and integrated resorts.

Fiscal policy is also effective because of its supply-side effects. The government, through the Economic Development Board (EDB), offers tax investment incentives to attract high value-added industries to Singapore. These not only boosts aggregate demand, but also aggregate supply too. In its annual budget announcements, the government usually invests in education and training, infrastructure development and research and development. These measures boost the overall productivity of


the economy, aggregate supply and thus Singapore’s long-term economic growth potential.

Synthesis

In conclusion, fiscal policy is NOT always the most effective way for Singapore to sustain a successful economy due to its many limitations. However, it remains a powerful counter-cyclical tool in the Singapore context that catalyses economic growth and recovery in times of recessions and fiscal drag in times of overheating. It is also an important instrument for socio-economic engineering, as seen in government fiscal budgets announced in February yearly. To achieve and sustain a truly successful economy, fiscal policy has to be supplemented by other complementary demand-side and supply-side policies in a judicious mix that can minimise policy conflicts.

Mark Scheme for part (b)

L1 1-4 marks For an answer that shows a descriptive knowledge of fiscal policy

L2 5-6 marks For an answer that is one-sided or undeveloped, e.g. explains antithesis of why fiscal policy is NOT the most appropriate way without considering thesis

L3 7-9 marks Uses analysis to underpin an evaluative discussion of whether fiscal policy is the most appropriate way for Singapore to sustain a successful economy & considers alternate policies

EvaluationE1 1-2 marks Unexplained assessment that is not supported by analysisE2 3-4 marks Evaluative assessment based on analytical discussion

Essay Question 3


(b) Discuss whether demand-side policies are the most appropriate way for Singapore to sustain a successful economy. [13]

SAJC Block Test 2, 2008

Big Ideas: Demand-side policies, successful economy

Enduring Understanding: Demand-side policies need to be complemented by supply-side policies to sustain a successful economy over the medium to long-term.

Essential Questions: What are demand-side policies? What is meant by a successful economy? How can demand-side policies sustain a successful economy? Why are demand-side policies the most appropriate way? Why are demand-side policies NOT the most appropriate way?

Suggested Approach:

Explain key terms first: demand-side policies that include fiscal, monetary and exchange rate and trade policies. Sustain => over time, over medium to long-term

What is meant by a successful economy?

Before evaluating the effectiveness of fiscal policy, it is prudent to interpret the meaning of a successful economy first. A successful economy is one which not only experiences strong and sustainable growth, low inflation, low unemployment rates and a favourable balance of payments position, its also enjoys economic stability and attains its microeconomic objectives of social equity, provision of public goods and low or reduced negative externalities. Ultimately, for an economy to be truly successful, the attainment of micro and macroeconomic objectives should translate into a higher (material and non-material) standard of living for the people.

THESIS: Demand-side policies are the most appropriate

Expansionary AD policies are appropriate for stimulating or sustaining economic growth and reducing cyclical unemployment. They need not necessarily cause DD-pull inflation if there is considerable excess capacity in the economy, i.e. economy is not at near or full employment level of output.

DD-side policies also have supply-side effects, via:

(i) reducing the size of the public sector and freeing more societal resources to the private sector, which is assumed to be more competitive, efficient and productive, hence raising economic growth potential;

(ii) reducing taxes to increase incentive to work, enhancing productivity and hence AS. Also, reducing corporate tax rate in Singapore encourages more investments in Singapore, which adds to Singapore’s productive capacity. These include training and R&D.


ANTITHESIS: Demand-side policies are NOT the most appropriate

Expansionary DD-side policies can lead to demand-pull inflation if the economy is already at or near full employment level of national output.

DD-side policies only increase the actual economic growth; but not growth potential. Until recently, Singapore has been able to keep inflation low partly because of its emphasis on SS-side policies (e.g. structural reforms) that expands long run AS.

SS-side policies also have DD-side effects, e.g. policies on education and training, infrastructure development and R&D enhances overall productivity in the economy. Singapore’s resultant skilled and competitive workforce becomes an additional factor that attracts foreign investments to Singapore. This raises AD.

DD-side policies may be insufficient to reduce the growing income gap within the population, improve the non-material aspects of SOL, or may not meet all microeconomic objectives.

SYNTHESIS:

To sustain a truly “successful” economy over time, DD-side policies need to be complemented by other micro and macro economic policies that not only keeps inflation and unemployment rates low, or sustain a stable economic growth, but also a favourable BOP position for Singapore and ultimately improves the SOL of the population, including the non-material aspects as well.

Mark Scheme for part (b)

L1 1-4 marks For an answer that shows a descriptive knowledge of demand-side policies

L2 5-6 marks For an answer that is one-sided or undeveloped, e.g. explains thesis of why DD-side policies could be the most appropriate way without considering antithesis

L3 7-9 marks Uses analysis to underpin an evaluative discussion of whether demand-side policies are the most appropriate way for Singapore to sustain a successful economy & considers alternate policies

EvaluationE1 1-2 marks Unexplained assessment that is not supported by analysisE2 3-4 marks Evaluative assessment based on analytical discussion

Essay Question 4


“With asset prices falling in many key markets, soaring energy and commodity prices stoking inflation, and global growth on a downturn, the world faces some difficult policy choices”.

- IMF First Deputy Managing Director John Lipsky, 22nd July 2008

(a) Explain the macroeconomic impact of the above on Singapore. [12]

(b) Assess the policies that the Singapore government can adopt to reduce the harmful effects of these problems. [13]

- SAJC Prelims, 2008

Big Ideas: Stagflation, economic policies

Enduring Understanding: Singapore is vulnerable to adverse external developments such as global stagflation. It can at best adopt measures to reduce the harmful effects of global stagflation but not eliminate them completely.


How can falling asset prices in many key markets, soaring energy and commodity prices stoking inflation and global growth on a downturn affect Singapore’s macroeconomy?

Which macroeconomic variables are affected? Affected most?

What appropriate economic policies can be adopted to reduce the harmful effects of these problems?

What are the strengths and limitations of each policy adopted?

Which is the most appropriate/effective policy? Why?

Part (a) Suggested Answer Scheme

1. Asset (property & stock) prices falling → ↓ wealth effect → ↓ C → ↓ imports → ↓ QX of goods and services from Singapore → ↓ X

2. Soaring energy & commodity prices → ↑ Pm for Singapore → ↓Qm (Law of DD)Because of Singapore’s lack of natural resources and thus heavy reliance on imports, PEDm < 1.Thus, ↓Qm is proportionately less than ↑ Pm → So Pm X Qm = M ↑

3. Global growth on a downturn → ↓ X and ↓I (less profits & investment funds)

4. Combined effect on ↓C, ↓I, ↓X, M↑→ AD↓ and LRAS↓ (via ↓I) (AD-AS diagram)

5. Explain further impact on Singapore’s external economy:↓ X - M ↑ = BOT ↓


→ Current account position ↓, ceteris paribus Also, capital & financial account position ↓ (due to ↓ in FDI)→ BOP position ↓, ceteris paribus→ SGD depreciates against foreign currencies→ FX reserves ↓ so as to maintain stable exchange rate

6. Explain further impact on Singapore’s domestic economy:AD↓ → via downward (or reverse) multiplier process → multiplied ↓ in equilibrium level of national income => negative economic growth

AD↓ → ↓ Derived demand for factors of production → N ↓ or U ↑Upward & leftward shift of LRAS (due to ↓I and ↑cost of production due to imported inflation) is greater than leftward shift of AD curve → ↑ GPL => Inflation

Part (a) Suggested Mark Scheme

L3 9-12 marks For an in-depth analysis of macroeconomic impact on Singapore’s external and domestic economy using AD-AS framework

L2 5-8 marks For an understanding of impact on either Singapore’s domestic or external economy or both but limited in range of points

L1 1- 4 marks For a descriptive knowledge of the impact without economic framework or largely irrelevant answers or that meaning of question is not grasped.

Part (b) Suggested Answer Scheme

As time can only permit candidates to analyse at most 3 policies, they should choose at least one AD policy and at least one AS policy for a balanced answer.

Acceptable AD policies:

1. Expansionary Fiscal Policy via ↑G and/or ↓T2. Depreciate SGD to ↓PX or appreciate SGD to ↓ imported inflation3. Diversify export markets (the latest being Africa/Middle East)

Acceptable AS policies:

1. Measures to boost productivity growth to exceed wage growth so that ↓ULC to improve export competitiveness. These measures include education and training, infrastructure development & R&D.

Acceptable AD-AS Policy:

1. Measures to promote investments → ↑AD and ↑LRAS


While candidates are encouraged to evaluate the strengths and limitations of each policy before discussing the next policy, those that reserve evaluation at the end of their essay should also be duly awarded evaluation marks.

When asked to assess, candidates are to:(i) compare the strengths and disadvantages/limitations of all the suggested

policies;(ii) recommend which are the key policies that would be most critical and what are

the good-to-haves.

Part (b) Suggested Mark Scheme

L3 7-9 marks For a well-balanced analysis that considers appropriate AD and AS policy responses that reduce the harmful effects of problemsL2 5-6 marks For an understanding that considers either AD or AS policy

solutions or even both but limited in range of pointsL1 1-4 marks For a mere description of policy solutions without linking to how

they reduce the harmful effects of the problems. Alternatively, for a largely irrelevant answer or shows that meaning of question is not grasped.

EvaluationE2 3-4 marks Judgment based on analysis.

Assess strengths and limitations of each policy, or which policy can be most effective, efficient and appropriate in Singapore’s context, or that policy responses may not completely solve, but only reduce severity of harmful effects, depending on the duration and severity of global slowdown/recession/stagflation.

E1 1-2 marks For an unexplained judgement, or one that is not supported by economic analysis

Essay Question 5


In view of the internal and external challenges facing the Singapore economy, discuss whether the Singapore government has adopted the most appropriate economic policies to overcome these challenges. [25]

- SAJC Mock Exams, 2008

Big Ideas: Internal and external challenges, demand-side and supply-side policies

Enduring Understanding:

In reality, there is often a myriad of domestic and foreign challenges confronting the Singapore economy at the same time. Among the challenges identified, the most significant challenge in the immediate term is to lift the Singapore economy out of recession. Due to the global nature of the economic slowdown, implying that many of Singapore’s export markets have slowed down, it would be difficult to restore economic growth so soon. This is because there are so many factors beyond Singapore’s control, much depends on how severe and prolonged is the current global financial crisis and global economic slowdown.


What are the internal and external challenges facing the Singapore economy? How can these challenges harm Singapore if nothing is done to confront

them? What are the current measures adopted by the Singapore government to

overcome these challenges? Are they the most appropriate measures? Why and why not?

Suggested Answer and Mark Scheme

While the following list of internal and external challenges is not exhaustive, they are some of the more pertinent issues confronting the Singapore economy today. Candidates should select and discuss in-depth at least 2 internal and 2 external challenges, policy solutions and their appropriateness.

Internal Challenges:(1) Labour supply, such as ageing population, brain drain & declining fertility rate(2) Productivity growth lagging behind wage growth(3) Rising business costs(4) Widening income gap(5) Ageing population – shrinking workforce

External Challenges:(1) Global economic slowdown(2) Increasing international competition(3) Rising imported inflation

Beyond mere listing, briefly explain how each of the above challenges can result in negative consequences for Singapore.


Labour Supply

Ageing population Lower energy level -> low labour productivity -> LRAS ↓ -> lower economic

growth potential

Economic Policies

→ Unless there is a medical breakthrough, there is currently no available policy, economic or otherwise, to overcome slowing productivity growth due to ageing.

→ In view of labour shortage, government in recent years introduced policies to extend the retirement age and to encourage employers to hire older workers

Brain Drain

→ Loss of talent & experience to other countries due to working abroad, marriage to foreigners and emigration→ Size of labour force ↓, worsen labour shortage→ LRAS ↓ → Lower economic growth potentialEconomic Policies

→ Efforts are made to keep in touch with Singaporeans working and living abroad to help them stay connected to Singapore (via website, embassy functions, etc)→ Incentives are given to attract foreign talent and immigration to replace those who have emigrated. Evidence that suggests it is working: Population has risen to 4.84 million, of which many of the recent increase is due to foreigners becoming Singaporeans.

Declining Fertility Rate

→ Over the very long term, it reduces the size of indigenous labour force → Without infusion of foreign labour and talent or re-hiring of retirees, the size of

the labour force will gradually shrink→ ↓ LRAS

Economic Policies

Recently, the government introduced measures to encourage more young adults to marry and to bear children.

Public education or publicity about parents in China match-making their children inspired some parents in Singapore to do likewise.

The jury is still out as to how effective these measures and incentives will be in arresting the decline in fertility trend. Only time will tell. Beyond financial incentives, non-economic social policies that offer a more supportive environment for married women to bear and to raise wholesome children.


Productivity Growth lagging behind Wage growth

In recent months, labour productivity growth has been lagging behind wage growth. This raises the unit labour cost (ULC) and unit business cost (UBC) of doing business in Singapore, and makes Singapore’s exports less internationally competitive.

If left unchecked, X ↓→ BOT↓, ceteris paribus → AD ↓, ceteris paribus→ via downward or reverse multiplier process, it leads to a more than proportionate ↓ in equilibrium level of national income→ slowdown in economic growth or even recession

BOT↓ → current account ↓, ceteris paribus → BOP ↓, ceteris paribus

Economic Policies

Measures to improve productivity growth have been on-going and low-key at the corporate level and at SPRING Singapore. Measures to make Singapore’s wage system more flexible via monthly variable component (MVC), bonus and adjustments to employers’ contribution to CPF have helped to some extent. What is more important that they be effective in causing productivity growth to exceed wage growth consistently over time.

Rising Business Costs

↑DD > SS of land & labour → ↑ rising land rental and labour cost → ↑ COP → ↓ profit margins

→ Some FDI relocate from Singapore to lower-cost countries → ↓AD & ↓LRAS → lower actual and potential economic growth

Also → structural unemployment

Economic Policies

In times of recession or slowdown, e.g. SARS 2003, the Singapore government eased business costs by lower foreign worker levy, reducing corporate income taxes and other statutory fees. These are emergency stop-gap measures but may not solve the fundamental issue of resource scarcity & thus rising business costs.

Growing Income Gap

Due to economic growth and globalization, the income gap between the minority rich and the middle and lower-income classes is widening.


Economic Policies

The government has introduced measures such as economic restructuring shares, growth dividends, utility rebates, progressive personal income tax system as a way of improving social equity via income redistribution.

These policies have been largely accepted by the population and especially welcomed by those staying in 1 to 3 room HDB flats. But one may question the wisdom of this approach since a number of rich retirees and single working adults are known to stay HDB flats with less number of rooms.

The measures, though laudable, at best reduce but not eliminate income gap. A complementary policy is to educate and train or upgrade the skills of those in the lower-income group so that they could earn higher wages.

Global Economic Slowdown

The current global economic slowdown, sub-prime mortgage crisis and contagion effect reduce income growth and exerts a negative wealth effect on many households and consumers throughout the world (e.g. fall in share prices and housing re-sale values).

→ ↓ income in Singapore’s export markets → ↓ DD for Singapore’s exports → ↓AD → via reverse or downward multiplier process → more than proportionate ↓ in equilibrium level of national income → ↓ economic growth or worse, recession

Singapore’s external economy is more badly and directly hit than the domestic economy due to its larger size. The degree of impact on Singapore depends on how deep or severe is the global economic slowdown, how prolonged or brief.

Economic Policies

Recently, MAS adopted a neutral (or zero) S$ appreciation stance, in effect allowing the S$ to weaken (according to market forces of demand and supply) against a trade-weighted basket of foreign currencies of Singapore’s major trading partners and competitors.

→ ↓Price of exports in US$ terms → Quantity demanded for Singapore’s exports to rise (Law of Demand)

→ If the Marshall-Lerner condition is satisfied, i.e. PEDx + PEDM > 1, then a depreciation of the S$ will improve Singapore’s BOP position.

This must imply that X↑ → BOT = (X-M) ↑ → current account position ↑

Evaluation

Too much S$ depreciation can worsen imported inflation for Singapore.


However, given the easing of food and oil prices in recent months, consumer price inflation has dampened to some extent. It is thus a calculated move on MAS’ part to adopt a more neutral S$ policy stance. In the short run, it is not sufficient to stave off recession. (Singapore has slipped into a technical recession).

Intensifying International Competition

International competition for export markets, investment dollar, tourist dollar and foreign talent is intensifying.

This threatens Singapore’s aim to be a vibrant, innovative and dynamic economy.

Economic Policies

Policies and incentives to attract the Arts, night life, high-profile events (F1 night race and Youth Olympics) and new industries (such as biomedical sciences, digital and interactive media) have been successful to some extent.

Evaluation

Among the challenges identified, the most significant challenge in the immediate term is to lift the Singapore economy out of recession. Due to the global nature of the economic slowdown, implying that many of Singapore’s export markets have slowed down, it would be difficult to restore economic growth so soon. This is because there are so many factors beyond Singapore’s control, Much depends on how severe and prolonged is the current global financial crisis and global economic slowdown.

Mark Scheme

L3 15-21 marks For a well-balanced discussion of both internal and external challenges confronting Singapore today, their policy solutions and the merits and demerits of those policies.

L2 10-14 marks For an understanding of the link from challenges to policy solutions and critique of these policies, but lacking in depth of answers.

L1 1-9 marks For a descriptive answer that lacks underlying economicsEvaluationE1 1-2 marks Unexplained judgmentE2 3-4 marks Judgment supported by economic analysis

Essay Question 6

NJC 2009 PRELIM ESSAY Q5


Discuss how the characteristics of being ‘small’ and ‘open’ has influenced the policy options of the Singapore government. [25]

Notes: (i) It would be necessary to provide some historical account of the various policy

options which were influenced by the nature of Singapore’s economy. It is important that such policy considerations would also extend to the future as well.

(ii) State the aims of the govt – broadly: improve SOL of the citizens, which includes more than merely the four macro indicators.

(iii) Do not restrict the policies to those under macro policies. Need to include various other policies where relevant in order to achieve the aims stated.

For example, widening income gap is exacerbated by the international flow of foreign labour and foreign talents due to the smallness and openness of our economy. Such nature of our economy has therefore instructed our government to implement policies to narrow the income gap.

Introduction Background knowledge of policies implemented by the Singapore government

should be provided. In Singapore, in favourable economic conditions, a strong S$ exchange rate policy and prudent fiscal policy is advocated. Singapore government has also focused mainly on supply-side policy, so as to ensure that our economy is best positioned to benefit from favourable conditions in the external economy.

Singapore government would also adjust policy implementation according to fluctuations in the external economy. Other policies

Body The characteristic of being ‘small’ means that Singapore is resource-scarce as

an economy, especially in terms of land and physical capital resources to sustain its rapid actual growth. It is also thus import-reliant, and bulk of our imports consists of raw materials and necessities. Given the small size of domestic market relative to the world’s economy, Singapore is thus dependent on the external economy in terms of both import of inputs as well as a source of export demand. We also need to constantly seek inflow of FDI as additional impetus for actual growth.

Singapore as an ‘open’ economy has relatively low import tariffs in almost all goods and services. Our economy is thus more vulnerable to fluctuations in the world’s economy, and is susceptible to significant impact in times of global boom and recessions. Being ‘open’ also implies significant integration with other economies in terms of labour and capital markets, and thus Singapore is more vulnerable to problems associated with the liberalisation of such markets.

As an example, Singapore does not have capital control and funds are free to flow in and out of the economy. When other capital markets around the world begin to become more attractive due to liberalisation in terms of rates of returns as well as broader scope of assets offered to investors, there might be significant outflow of funds from Singapore’s capital markets.


Due to the characteristics of being ‘small’ and ‘open’, Singapore is an interest-rate taker. As such, monetary policy is ineffective and is thus not implemented by the Singapore government.

Given that Singapore is import reliant due to it being ‘small’, Singapore government views that inflationary pressures in our economy are likely to be imported in nature. Thus, in order to achieve price stability in the economy, Singapore government implements a strong S$ exchange rate policy to curb imported inflation. By allowing S$ to appreciate, imports become relatively cheaper in terms of domestic currency.

Given that bulk of Singapore’s imports are raw materials and necessities, since Singapore is resource scarce, demand for imports is expected to be relatively price-inelastic. Hence, import expenditure would fall and this translates to lower cost of production for firms. This helps to shift AS curve downwards and curb imported inflation (illustrate with diagram). As necessities become cheaper in terms of domestic currency, this would also lower GPL as price of final goods & services are lower.

However, with an appreciation of S$, exports also become relatively more expensive in terms of foreign currencies. Given that Singapore exports mainly consumer electronics and manufactured goods, demand for exports is expected to be price-elastic given that there are many close substitutes produced by other industrialised nations such as Taiwan.

This means that export revenue is expected to fall. Given that demand for exports is price-elastic, Marshall-Learner condition holds, whereby sum of elasticities of demand for imports and exports are greater than 1, hence net exports (i.e. X-M) is expected to fall. Hence, slowdown in actual growth results in cyclical unemployment. This thus conflicts with the other macroeconomic aims of the government.

In favourable economic conditions, there is thus a compromise in terms of export competitiveness. Thus, Singapore government implements supply-side policies to stimulate R&D and innovation efforts to improve on the quality and attractiveness of its exports. Policies implemented to improve export competitiveness in Singapore are focused on the quality of our products rather than the price competitiveness. The ‘small’ characteristic thus explains the focus on supply-side policies in Singapore.

Moreover, given that Singapore is an ‘open’ economy, it is also susceptible to changes in export demand. Hence, if there were changes in tastes and preferences, such that our exports lose its attractiveness, then policy measures should be implemented to mitigate the fall in our export revenue. This explains why Singapore is restructuring its economy towards more knowledge-based, high value-add exports so as to reduce the PED value of our exports. As such, there is a need to implement retraining programmes to equip lowly-skilled workers with the required skills in order to reduce structural unemployment in our economy. This further explains our focus on supply-side policies.


Given the small size of the domestic economy, Singapore is dependent on net exports and foreign direct investments for its growth. In particular for Singapore, to sustain the rapid actual growth rates brought about by net exports and capital inflow, there is a need to implement supply-side policies that target potential growth. This explains the widespread implementation of interventionist supply-side policies with respect to land, labour, capital and entrepreneurship. One such example would be the need to multiply our land by the construction of flatted factories around neighbourhood areas as well as the Jurong Island.

Manpower policies are also focused on attracting both foreign talent and foreign labour to enhance our productive efficiency, helping to sustain economic growth in our economy. The increase in cheaper foreign labour also helps Singapore achieve lower cost of production, leading to more price competitive exports. However, this would also lead to structural unemployment as domestic unskilled labour may face a loss of jobs to such foreign labour. Again, supply-side policies to retrain the workers would be required.

A natural outcome of such open door policy to both foreign labour and foreign talent would be the onset of widening income gap. Hence, this openness has also helped shaped the mindset of policymakers to contain the ill effects of such potential widening income gap among the population (especially the local, lower-skilled workers). For example, the need to provide help to the needy and lower-income families whenever there is a rise in COL (e.g. setting up of Public Transport Fund to help offset the upward revision of public transport fares).

The fact that Singapore is a relatively open economy also implies that it is vulnerable to fluctuations in the external economy. As such, Singapore’s economy is closely linked to changes in the world’s economy. As such, during times of world recession, Singapore’s economy would similarly be affected by export slump and fall in foreign direct investment. Thus would lead to a fall in AD and a corresponding more than proportionate fall in national income via the multiplier process. Thus results in a slowdown in actual growth and increase in cyclical unemployment in our economy.

In such times of economic downturn, Singapore’s economy thus needs adequate funds to implement expansionary fiscal policies in order to stimulate the economy. An example would be the Resilience Package that was implemented in 2009 to cope with the effects of the current financial crisis. Thus, maintaining a prudent fiscal policy in times of healthy economic growth would allow the government to build up its government adequate reserves for implementations of appropriate expansionary policies in times of global downturn.

Conclusion The characteristics of being ‘small’ and ‘open’ have significant impact on the

policy options in Singapore. These characteristics have led to unique set of multi-faceted causes of potential problems in Singapore, significantly influencing the policy options chosen in order to achieve the macroeconomic aims.

A policy package would be required to achieve the macroeconomic aims as each policy implemented would not be able to fully address the problems, and each policy has its limitations.


It should be noted that policy implementation in Singapore would have to be adjusted according to the changes in the external economy. This is due to the combined characteristics of being ‘small’ and ‘open’ whereby Singapore is a price taker and susceptible to changes in world’s demand and supply conditions. As such, our policy options are focused on supply-side policies.

Mark SchemeLevel DescriptorsL1 (1-5) Only a few valid points made incidentally in an irrelevant context.


(6 – 9 ) Answer shows some weak knowledge of policies that may be implemented but limited application to achievement of macroeconomic aims.

Explanation has little or no reference to the AD-AS model. Several errors and inconsistencies occur in the explanation, showing

lack of understanding of the economic concepts. Little or no reference to characteristics of ‘small’ and ‘open’ in

relevance to Singapore context.L2(10 – 11)

(12 – 14)

Answer shows some knowledge of appropriate policies but underdeveloped explanation and weak application to achievement of macroeconomic aims.

Explanation has some reference to the AD-AS model. Little or no reference to characteristics of ‘small’ and ‘open’ in

relevance to Singapore context. Answer shows some knowledge of appropriate policies with adequate

rigour in explanation and some application to achievement of macroeconomic aims.

Explanation has some reference to the AD-AS model. Some reference to characteristics of ‘small’ and ‘open’ in relevance to

Singapore context. Lack of specific contextual examples.

L3(15 – 17)

(18 – 21)

Answer shows good knowledge of appropriate policies with adequate rigour in explanation and good application to achievement of macroeconomic aims.

Explanation has good reference to the AD-AS model. Good reference to characteristics of ‘small’ and ‘open’ in relevance to

Singapore context and good explanation on its influence on policy options.

Some specific contextual examples. Essay lacks synthesis and a comprehensive structure. Answer shows excellent knowledge of appropriate policies with

adequate rigour in explanation and excellent application to achievement of macroeconomic aims.

Explanation has good reference to the AD-AS model. Excellent reference to characteristics of ‘small’ and ‘open’ in

relevance to Singapore context and excellent explanation on its influence on policy options.

Rich use of specific contextual examples. Essay has synthesis between points and a comprehensive structure.

EvaluationE1 (1 – 2) Mainly unexplained judgment on the influence of ‘small’ and ‘open’ on

policy options in Singapore.E2 (3 – 4) Judgment based on economic analysis on the influence of ‘small’ and

‘open’ on policy options in Singapore.


Documents

Macro Economic Problems Policy Tutorial (2010)v6- For Students