CURTIN UNIVERSITY OF TECHNOLOGY

CURTIN BUSINESS SCHOOL

School of Economics and Finance

 

 

ECONOMICS (MACRO) 202

SEMESTER1, 1998

ASSIGNMENT

 

 

Prepared For :     Garry MacDonald / Dave Western

Prepared By :    Chow Tai Wei, David

Student No. :     977438B

 

---

TABLE OF CONTENTS

1. INTRODUCTION *

2. Singapore’s Economic Development *

2.1 1965 to 1970s: From Entrepot to Industrialisation *

2.2 1980s: Industrial Restructuring *

2.3 1990s: Looking beyond Singapore *

3. FISCAL VS MONETARY POLICY *

3.1 Effectiveness of Fiscal Policy *

3.2 Monetary Institutions *

3.3 What about Monetary Policy? *

3.4 Exchange Rate Policy *

3.5 Fiscal Policy Revisited *

4. CONCLUSION *

5. LIST OF REFERENCES *

The purpose of this assignment is to discuss the current economic policy of a government. The economic scene of Singapore is chosen to examine the broad settings of the types of policies adopted by the Singapore government in sustaining low inflation and unemployment rate, and upholding a healthy balance of payment with current account surplus since the 1980s. We shall focus on those policies that possess a more direct impact on the performance of the economy --- and shall limit the primary concern here on Singapore’s monetary policy.

A country’s economic policies are political variables subject to many influences and cannot be appreciated without knowledge of their history of economic development. The first section of this assignment traces briefly the history of Singapore’s economic development since her independence. The second section starts with a brief comparison of the effectiveness of fiscal and monetary polices in small open economies like Singapore’s, introduces the more potent monetary policy, its institutions and the instruments used to achieve their economic objectives.

Singapore thrives as a successful business centre in the international arena. This situation has evolved gradually and has come about as a result of careful planning.

 

2.2    1980s: Industrial Restructuring

By 1980s, the government faced the new challenge of restructuring the economy towards higher value added activities in the face of a tight labour market. Development strategies then were:

1. Introducing a three-year wage correction policy so that wage increases would reflect the tight labour market;
2. Renewed emphasis on education and training. Enrolment in the polytechnics and universities was doubled as a result;
3. Encouragement of automation, mechanisation and computerisation;
4. More selective investment promotion policy;
5. Increased emphasis on R&D; and
6. Development of high value added services.

 

Figure 1: Economic growth and inflation rate from 1961-96 (Source: Singapore

Department of Statistic, 1998).

 

Singapore’s economic development was not always plain sailing. Growth was interrupted by the 1985 recession. The Economic Committee set up to set new directions for the Singapore economy also reviewed the reasons for the recession and recommend measures to cut costs (Rodan, 1989, p. 192). The recovery came in 1986.

Despite the setback of the recession, growth averaged 7.1% during 1980-90 and the unemployment rate fell to a record low of 1.7% in 1990.

 

2.3    1990s: Looking beyond Singapore

By 1990, Singapore had reached the ranks of a Newly Industrialised Economy (NIE). Domestically, the economy had become more matured where emphasis has been placed on both the manufacturing and service sector as the twin engines of growth. In addition, local enterprises have been encouraged to diversify their operations, promote R&D, upgrading their skills and develop into strong export-oriented companies (Lee, 1998). To achieve its vision of becoming a developed nation, Singapore "has to operate and compete in the global marketplace by tapping global resources, technology and talent [sic]" (MITA, 1997, p. 116).

Meanwhile, the economies in the region were enjoying rapid growth, which provides plentiful opportunities for Singapore by "going regional". Singapore had, since then continued to make progress in developing its external economy and ranked as a major investor in the region.

Rapid technological progress has revolutionised the world economy, creating new growth areas. Singapore has accordingly embarked on a major development thrust to develop indigenous science and technology base to support high-tech industries and to innovate and create new products and processes (Lee, 1998). In particular, the government recognises the need for Singapore to be early adopters of information technology (IT) and innovators of IT applications for the economy to remain vibrant and competitive (MITA, 1997). It is being pursued vigorously in the drive to transform Singapore into an IT mega-hub to remain ahead.

 

By looking at the various economic indicators, the Singapore economy has performed remarkably well since 1965. Structural transformation, full employment, improved living standards, price stability, good financial health, and a well developing external economy have accompanied rapid economic growth. Economic success has not been the result of a resource boom (like oil discoveries in Brunei), it was the result of a resourceful government and people able to take advantage of a strategic geographical location and a favourable external environment. Together they achieved political and social stability and economic development. Under an able and dedicated political leadership, Singapore was able to harness its energies and pursued appropriate economic and social policies to achieve what Singapore is today.

---

3.    FISCAL VS MONETARY POLICY

We now consider the macroeconomic issues, which arise when an open economy like Singapore attempts to achieve a number of domestic and external goals.

 

3.1 Effectiveness of Fiscal Policy

The framework used to analyse these problems was the IS-LM-BP model (see Dornbusch, Fischer & Kearney, 1995, ch. 15). When represented in two dimensions the slopes of the three curves were drawn to capture, as far as possible, the known characteristics of the Singapore economy, in particular a relative steep IS curve and, crucially, a perfectly elastic BP curve, which emphasises the very high degree of short-term capital mobility. As shown graphically below, fiscal policy is relatively ineffective as a stabilisation tool in open economies with flexible exchange rates and high capital mobility, compared to monetary policy.



Figure 2: Fiscal expansion under floating exchange rates and perfect capital mobility in IS-LM-BP model. A fiscal expansion will raise interest rates and attract short-term foreign capital when the IS curve shifts right to IS’. This in turn, leads to a currency appreciation, a worsening of the current account and the shifting of the IS curve back to the left until initial IS-LM-BP equilibrium is restored.

But other factors also come into play in Singapore. Peebles & Wilson (1996) listed three: "the wealth effect of tax policy is reduced by CPF contributions; the fiscal crowding out of domestic investment is small since interest rates are set by the world market; and the very high marginal propensity to import reduces the multiplier effects on domestic income of any fiscal expansion or contraction".

 

3.2 Monetary Institutions

Before we move on, I shall briefly introduce the institution that play an important role in implementing monetary policy in Singapore. The Monetary Authority of Singapore (MAS) is the de facto central bank of Singapore. Except for the issue of currency, which is presently entrusted to the Board of Commissioners of Currency, Singapore (BCCS), it formulates and executed Singapore’s monetary and exchange rate policies. As banker and financial agent to the government, it manages the country’s official reserves and facilitates the issuance of government securities.

 

3.3 What about Monetary Policy?

In Singapore, a large proportion of changes in the money supply are due to net flows from aboard via external sector less foreign assets. Therefore controlling M1 is too small to have any effect on an ultimate target such as inflation. On the other hand, M2 and M3 are affected by international money markets and thus not stable or controllable by MAS (Peebles & Wilson, 1996). This means that interest rates cannot be used as effective instruments since they are tied to international rates. Even if the MAS decided to use monetary policy for domestic goals, the small domestic secondary market for government securities reduces the effectiveness of open operations (Peebles & Wilson, 1996).

Due to Singapore’s high dependence on imports, increases in import prices have a significant effect on domestic prices. As Peebles & Wilson (1996) sums up: "[t]he monetarist link between the money supply and the aggregate price level is, therefore, less important than the link through import prices". Thus, the MAS believes that assigning external monetary policy (targeting at the exchange rate) is the most effective way to achieve its domestic objectives of maintaining low inflation and unemployment (Teh & Shanmugaratnam, 1992).

 

3.4 Exchange Rate Policy

Singapore operates a managed float of the Singapore dollar, monitoring its value against a currency basket representing Singapore’s principal trading partners. To attain its goals of price stability and sustained economic growth, the MAS intervenes frequently on the foreign exchange markets. Since 1981 managed floating in Singapore has been linked directly to a ‘strong Singapore dollar’ policy. Figure 3 overleaf shows the Singapore dollar appreciated against the US dollars (and other currencies of most of its trading partners with the exception of Japan) since 1985.

In principle, the MAS can use exchange rate policy to offset any pressures, domestic or foreign, for inflation to rise beyond its predetermined level consistent with a target for employment. If there is a sharp increase in import prices, the MAS will keep domestic prices from rising as fast by letting the Singapore dollars appreciate. However, once the exchange rate is the target, the money supply becomes a by-product of this policy. To illustrate, assuming MAS were to intervene to push up the Singapore dollar by selling US dollars from its official reserves and buying the Singapore dollar in the open market, the money supply would automatically decrease (similar to the effect of a tight monetary policy).



Figure 3: Percentage change in the value of US$1 measured in East Asian currencies (Relative to the benchmark rates in September 1985) (Source: Institute of Developing Economics, 1998)

 

Monetary policy is also relatively free to focus on domestic inflation and unemployment because there is no conflict with fiscal policy.

So far, our discussion on monetary policy fits into the general framework described by Simkin (1984). This framework was represented in Figure 4 overleaf:

Figure 4: Schema for monetary policy in Singapore. Note that solid arrows indicate the main channels of causation; broken line arrows show secondary causation. Here, the world interest rates are the major determinant of domestic interest rates. The high domestic savings rate in Singapore, largely due to CPF and public sector surpluses tends to drain liquidity from the domestic banking sector. Given the liquidity drain, changes in the money stock depend on net capital inflows and MAS intervention in the forex market to prevent "undue" appreciation of the Singapore dollar. As mentioned earlier, with a managed exchange rate, the money stock emerges as a result of exchange rate targeting. Foreign prices and the exchange rate determine the domestic prices of tradeables, which in turn are a major determinant of liquidity. At the far right of the chart, we have domestic exports depending on world demand as well as domestic supply. The latter depends on domestic liquidity to finance working capital, and domestic investment, which also depends on liquidity both from foreign capital inflows and domestic borrowing, the expected rate of return and the expected exchange rate. The major determinants of GDP are exports and investment with the output of non-tradeables playing a secondary role. GDP is, of course, an important determinant of liquidity. (Source: Simkin, 1984)

 

3.5    Fiscal Policy Revisited

As discussed in section 3.1, fiscal policy has little impact in the IS-LM-BP model. However, as a price-taker in international markets, stabilisation policies have a role to play in "keeping Singapore goods and services internationally competitive, sustaining investor confidence through prudent fiscal policies, accumulation of foreign reserves and (not the least) a strong currency" (Lim et al, 1988, p. 362). The second role of fiscal policy, the promotion of economic growth, has been top in the priority list in Singapore’s economic development. Fiscal, monetary and exchange rate policy have been treated as a coherent package to provide an environment supportive of long term sustained growth. With respect to fiscal policy, the emphasis has been on domestic revenue (resource) mobilisation and expenditure control. Since government spending has been heavily oriented towards capital projects, the benefits are shifted to the future (Lim et al, 1988).

---

4.    CONCLUSION

Because of the sound and prudent financial management by the Singapore government, macroeconomic environment is stable. Fiscal policy in Singapore is guided by the principle that it should support the private sector as the engine of growth. The Singapore government has been very prudent and conservative in its budgetary policy and has balanced its budget for the last 25 years. Monetary policy is geared towards keeping inflation low and stable for long-term competitiveness.

But the regional financial crisis that started in July 1997 has shown that macroeconomic stability alone is not quite enough. According to Lee (1998a), Singapore managed to largely ‘insulate’ itself from this financial turmoil not only because of its long-standing fundamentals but also due to tighter regulation and supervision of the financial sector (over the last 5 years), to prevent excessive credit growth and risk concentrations, and the build-up of large unsustainable positions that could endangered the whole financial system. Again, the MAS was responsible for the regulation and supervision which have pre-empted this breakdown of the financial intermediation process from happening to Singapore.

---

5.    LIST OF REFERENCES

Department of Statistic (1983), Economic and Social Statistics, Singapore, 1960-1982, Singapore.

 

Dornbusch Rudiger, Fischer Stanley and Kearney Colm (1995), Macroeconomics, Australian edition, McGraw-Hill, NSW.

 

Institute of Developing Economies (1998), Accessed at [http://www.ide.go.jp].

 

Lee Hsien Loong (1998a), Speech by Deputy Prime Minister, BG(NS) Lee Hsien Loong,

at the Investment Management Association of Singapore seminar at the Westin Plaza on 26 Feb.

 

Lee Yock Suan (1998), Speech by Minister for Trade and Industry and Second Minister

for Finance, Mr Lee Yock Suan, at the Economic Society of Singapore annual dinner at Shangri-la Hotel on 7 Mar.

 

Lee Sheng-yi (1990), The Monetary and Banking development of Singapore and

Malaysia, 3^rd ed., Singapore University Press, Singapore.

 

Lim Chong Yah et al (1988), Policy Options for the Singapore Economy, McGraw-Hill, Singapore.

 

Low, Vincent (1994), ‘The MAS model: Structure and some policy simulations’ in

Anthony Chin and Ngiam Kee Jin (ed.), Outlook for the Singapore Economy, Trans Global Publishing, Singapore.

 

Monetary Authority of Singapore (1980), The Financial Structure of Singapore, MAS, Singapore.

 

Ministry of Information and the Arts (1997), Singapore 1997, MITA, Singapore.

 

Ministry of Trade and Industry (1997), 1997 Annual Economic Survey of Singapore, MTI, Singapore.

 

Peebles Gavin and Peter Wilson (1996), The Singapore Economy, Edward Elgar Publishing, Cambridge.

 

Rodan, Garry (1989), The Political Economy of Singapore’s Industrialization: National

State and International Capital, The MacMillian Press, Hampshire.

 

Simkin C. (1984), ‘Does money matters in Singapore?’, Singapore Economic Review, vol. 29, No. 1, Apr.

 

Singapore Department of Statistic (1998), Accessed at [http://singstat.gov.sg].

 

The Kok Peng and Shanmugaratham Tharman (1992), ‘Exchange rate policy:

Philosophy and conduct over the past decade’, in Linda Low and Toh Mun Heng (eds), Public Policies in Singapore: Changes in the 1980s and Future Signposts, Times Academic Press, Singapore.

 

 

No. of words: 2002 (content only)

 

Return to Assignments for Semester 1, 1998