The Major Causes Of Inflation In Singapore Economics Essay

Introduction

First of all, we need to find out what is inflation. Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every pound you own buys a smaller percentage of a good or service. The value of a pound does not stay constant when there is inflation. The value of a pound is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a £1 pack of gum will cost £1.02 in a year. After inflation, your pound can’t buy the same goods it could beforehand.

There are several variations on inflation:

Deflation is when the general level of prices is falling. This is the opposite of inflation.

Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation’s monetary system. For example, one of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!

Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices

Findings:

Singapore was founded as a British trading colony in 1819. It joined the Malaysian Federation in 1963 but separated two years later and became independent. Singapore subsequently became one of the world’s most prosperous countries with strong international trading links (its port is one of the world’s busiest in terms of tonnage handled) and with per capita GDP equal to that of the leading nations of Western Europe.

Singapore has a highly developed and successful free-market economy. It enjoys a remarkably open and corruption-free environment, stable prices, and a per capita GDP equal to that of the four largest West European countries. The economy depends heavily on exports, particularly in consumer electronics and information technology products. It was hard hit from 2001-03 by the global recession, by the slump in the technology sector, and by an outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003, which curbed tourism and consumer spending. Fiscal stimulus, low interest rates, a surge in exports, and internal flexibility led to vigorous growth in 2004-07 with real GDP growth averaging 7% annually. The government hopes to establish a new growth path that will be less vulnerable to the global demand cycle for information technology products – it has attracted major investments in pharmaceuticals and medical technology production – and will continue efforts to establish Singapore as Southeast Asia’s financial and high-tech hub. Singapore’s annual inflation rate was at 6.7% in March – the highest since 1982 – and the republic is now paying a high price in becoming a global city of fine living.

Causes of inflation:

 

Cost Push Inflation

Cost-push inflation occurs when businesses respond to rising production costs, by raising prices in order to maintain their profit margins. There are many reasons why costs might rise:

Rising imported raw materials costs perhaps caused by inflation in countries that are heavily dependent on exports of these commodities or alternatively by a fall in the value of the money in the foreign exchange markets which increases the price of imported inputs. A good example of cost push inflation was the decision by British Gas and other energy suppliers to raise substantially the prices for gas and electricity that it charges to domestic and industrial consumers at various points during 2005 and 2006.

Rising labour costs – caused by wage increases which exceed any improvement in productivity.  This cause is important in those industries which are ‘labour-intensive’. Firms may decide not to pass these higher costs onto their customers (they may be able to achieve some cost savings in other areas of the business) but in the long run, wage inflation tends to move closely with price inflation because there are limits to the extent to which any business can absorb higher wage expenses.

Higher indirect taxes imposed by the government – for example a rise in the rate of excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard rate of Value Added Tax or an extension to the range of products to which VAT is applied. These taxes are levied on producers (suppliers) who, depending on the price elasticity of demand and supply for their products, can opt to pass on the burden of the tax onto consumers. For example, if the government was to choose to levy a new tax on aviation fuel, then this would contribute to a rise in cost-push inflation.

Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply curve. This is shown in the diagram below. Ceteris paribus, a fall in SRAS causes a contraction of real national output together with a rise in the general level of prices.

Average earnings comprise basic pay + income from overtime payments, productivity bonuses, profit-related pay and other supplements to earned income

Productivity measures output per person employed, or output per person hour. A rise in productivity helps to keep unit costs down. However, if earnings to people in work are rising faster than productivity, then unit labour costs will increase

The growth of unit labour costs is a key determinant of inflation in the medium term. Additional pressure on prices comes from higher import prices, commodity prices (e.g. oil, copper and aluminium) and also the impact of indirect taxes such as VAT and excise duties.

Prices also increase when businesses decide to increase their profit margins. They are more likely to do this during the upswing phase of the economic cycle.

The major causes of inflation and effect in Singapore:

Singapore’s inflation rate is double that of Malaysia, it is higher than Hong Kong and Australia. While inflation is generally higher around the world, Singapore’s inflation is far higher than the average for several reasons, here are the main ones:

.

One million people added to Singapore’s population in recent years causing the population to rise from 3.7M to 4.6M

An overheated economy that grew by 7% per annum.

GST hike, transport hike, utilities hike, kindergarten fee hike etc etc.

A strong overheating economy that grew by 7% annually for the past four years; and,

An open door immigration (the highest inflow rate in the world) that brought in a million foreigners and pushed the population to about 4.7 million.

This entry shows Singapore’s the annual percent change in consumer prices compared with the previous year’s consumer prices:

Inflation rate (consumer prices): 2.1% (2007 est.)

Year

Inflation rate (consumer prices)

Rank

Percent Change

Date of Information

2003

-.40 %

209

 

2002 est.

2004

.50 %

203

-225.00 %

2003 est.

2005

1.70 %

45

240.00 %

2004 est.

2006

.40 %

13

-76.47 %

2005 est.

2007

1.00 %

17

150.00 %

2006 est.

2008

2.10 %

43

110.00 %

2007 est.

Ways to decrease the Inflation:

Monetary Policy 

Increased interest rates will help reduce the growth of Aggregate Demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending because:

increased interest rates increase the cost of borrowing, reducing spending

Increased interest rates make it more attractive to save money

Increased interest rates reduce the disposable income of those with mortgages

2. Supply Side Policies

Supply side policies aim to increase long term competitiveness and productivity. For example, privatisation and deregulation were hope to make firms more productive. Therefore, in the long run supply side policies can help reduce inflationary pressures. However, supply side policies work very much in the long term. They cannot be used to reduce sudden increases in the inflation rate

3. Fiscal Policy 

This is another demand side policy, similar in effect to Monetary Policy. Fiscal policy involves the government changing tax and spending levels, in order to influence the level of Aggregate Demand. To reduce inflationary pressures the government can increase tax and reduce government spending. This will reduce Aggregate Demand.

4. Exchange Rate Policy

Policy of government towards the level of the exchange rate of its currency. It may want to influence the exchange rate by using its gold and foreign currency reserves held by its central bank to buy and sell its currency. It can also use interest rates (monetary policy) to alter the value of the currency.

This report illustrates 2 interesting tables:

This below table shows the rank of countries which has the most inflation. This entry furnishes the annual percent change in consumer prices compared with the previous year’s consumer prices.

This entry shows the annual percent change in consumer prices compared with the previous year’s consumer prices.

Summary

In today’s economy, changes in aggregate demand lead to changes in changes in prices as well as output. In fact, because of the inflexibility of wages, prices may be rising even though the economy still has high unemployment and unutilized capacity.

Inflation occurs when the general level of prices is rising (and deflation occurs when they are generally falling). Today, we calculate inflation by using “price indexes” weighted averages of the prices of thousands of individual products. The most important price index is the consumer price index, which measures the cost of a market basket of consumer goods and services relative to the cost of that bundle during a particular base year.

Inflation affects the economy in two ways: by redistributing income and wealth and by changing the level and pattern of production. Inflation and deflations are rarely of the balanced and anticipated type

References:

Parkin M., 2003, Microeconomics, 6th edition, Pearson Education, USA

Sloman J., 2004, Essentials of Economics, 3rd edition, Pearson Education, England

Samuelson.A and William D, Macroeconomics, 13th edition, McGraw-Hill book company, USA

http://news.bbc.co.uk/1/hi/wales/7061021.stm