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Singapore experienced a quarterly growth rate of -0.7% from April to June 2012. However during the same period, inflation rate remained high at about 5%.

“Inflation is harmful to an economy and hence it should be the priority of the Singapore government to reduce inflation.” Discuss. [15]

To consider whether inflation should be the main priority of the government there is a need to observe the inflationary condition in relation to other aims of the government base on the degree of impact on the economy.

Main Body

1. Explain the other macroeconomic aims of the government

Besides achieving price stability, other priorities of the government include attainment of economic growth, healthy balance of payments as well as full employment. Full employment refers to the full utilization of resources for the production capacity which is measured in term of employment rate. A healthy balance of payments implies a decent surplus which will affect the flow of the currency and thus affect the exchange rate.

2. Explain and evaluate why inflation is more severe economic concern and should be placed as the main aim of the government

Low inflation will ensure that the cost of living and cost of production is kept low. Internally, low inflation ensures cost of living is low to prevent unequal distribution of income as price increases for basic necessities will undermine the purchasing power of the lower income group while it raises the wealth of the rich when the price of assets appreciates. Low inflation can also help to maintain level of savings which is a critical source of funding for investment when the purchasing power and future value of money is maintained and thus, encourages the ability and willingness to save. Most importantly, low inflation will ensure that there will be improvement in standard of living, given that any percentage in GDP will be greater than percentage increase in price level, holding population growth constant, to induce a rise in Real GDP per capita.

Externally, low inflation is an important aim of the government as it maintains cost of production to ensure the country is able to develop competitiveness in the export market and in attracting Foreign Direct Investment (FDI). By keeping the cost of production low, the price of export in foreign value and the cost of FDI will be low to induce rise in export demand and FDI, critical to any economy that is export dependent. If the export demand and FDI have not been reduced, there will be no depreciation of the local currency which will affect the flow of fund into an economy that will affect the economy which has a financial centre for economic development.

Furthermore, curbing inflation will help to solve the negative impacts on other aims of government. By reducing cost-push inflation in terms of imported inflation, this reduces the cost of production for export firms in Singapore, which will translate to lower prices of final goods and hence improvement in export competitiveness, improving Singapore’s actual growth and hence balance of payments in current account. Likewise, lowering inflation stimulates investments, which increase actual growth in the short run, improves potential growth in the long run as well as balance of payments in the financial account. As such, focusing on low inflation as a macroeconomic aim is seemingly beneficial as the main priority.

3. Explain and evaluate why inflation should not be the main aim of the government

However, focusing on other aims of the government are equally, if not, more important as well. The attainment of actual growth and hence reduction of demand-deficient unemployment is able to reduce inflationary pressures. When employment and wages of workers are improved, it will reduce wage bargains from trade unions and hence dampen wage-push inflation.

Likewise, the attainment of potential growth is able to reduce inflationary impacts. The expansion of resource capacity due to the implementation of the long run supply-side policies such as manpower development and infrastructural development will increase the productive capacity of the economy. This will lead to a rise in the real GDP without any corresponding price increase as the expansion of the resource capacity has lowered down the cost of production.

Finally, by aiming to achieve a healthy balance of payments, it reflects the progress of the economy to ensure higher economic growth so as to dampen the effects of inflation, which are significant particularly for export-oriented industries like Singapore.

4. Evaluate the key determinants in evaluating economic priority

It is important to note that the cost of managing inflationary impact is lower than the cost of managing unemployment. The cost of managing unemployment is higher due to the lower tax revenue as a result of a smaller fraction of labour force who are employed, limited the government’s ability to expand its expenditure to enhance economic development and improve the well-bring of its population. This is in addition to the greater disbursement of unemployment benefits, which comes at the expense of the country’s other areas of development. As such, the focus on lowering inflation rather than maintaining full employment is more feasible and practical from the Singapore’s government’s perspective.

Furthermore, Singapore’s small and open economy which is largely dependent on external growth compels it to focus on low inflation as an important aim. This is because any changes in external prices of raw materials and food commodities will negative impact the firms’ cost of production as well as citizens’ cost of living.

Finally, one must assess the degree of inflationary impact in relation to the severity of recession in considering the focus of low inflation rather than other aims as the main goal of the Singapore government at that point in time. For example, if Singapore was suffering from severe recession as witnessed from the global financial crisis in 2009, the aims of attaining full employment as well as economic growth will be more important than achieving price stability.

In view of the harmful effects of inflation and Singapore’s economic characteristics, it can be understood that it is understandable and rational for governments like Singapore to place concern on achieving low inflation. Nevertheless, other macroeconomic objectives should not be sidelined, depending on the prevailing economic conditions.

Simon Ng

Founder, JC Economics & General Paper Tutor at Economics Focus
JC Economics Tutor Simon Ng of Economics Focus has been teaching A Level Economics and A Level General Paper since 2003. Simon set up Economics Focus to assist students in their pursuit of academic excellence at the examination by providing economics tuition for H1 and H2 students. JC1 and JC2 students are inspired by Simon's clear teaching methods that enabled them to comprehend economics terms and concepts. Simon developed the Rational Thinking methodology to aid students to excel in their JC economics essays and CSQs.