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6 Question 2 Extract4: Global FinancialCrisis Bank of England'sdilemma:A house price crash or soaring inflation

and housepricecrashor yearsof soaringseventiesWhichwouldyou ratherface:a recession styleinflation? was kept unusually low by the influxof cheapgoodsfrom China. For the past decade,inflation (UK's Bank of England could keep interestrates low without the Bank) meant Central This so have the and food ballooned, higher. But as China's for energy inflation appetite driving pricesof oil, wheat,meatand mostotherimportant staplegoods. It has come at the worst possibletime: the crunchin credit marketshas pushedup familbs' sloMown rateon homeloan).The UK economyis facingthe sharpest rates(interest mortgage prices property worst. is at its for the housing marketand in 16 yearsandthe outlook the Bank of Englandwould have alreadycut the officialinteret rde In normalcircumstances, dolg wouldfollowsuit with the rate of their homeloans.However, far and fast, hopinglenders abovethe target set. lt mght which is alreadystubbornly so would risk pushingup inflation, fior pain,butthis couldbe poisonous go and put off the immediate to let inflation seemtempting the economyin the long-run.Somejudiciousinterestrate cuts will help softenthe economic despitehavingcut the officialrate three while keepinginflationin check.However, slowdown risenby have actually times in the past five months,the mortgageratesfaced by households 1.25percent. around Apr2ffi Source:Telegraph,24 Extract 5: Dent in Singapore'sfinancial hub dream

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financialproductswhich had blonnrtfg Despiteits limitedexposureto the toxic securitized is in a bad way.That'sbecause economy sheets,Singapore's holesin Westernbanks'balance exports its economicgrowth is still highly reliant on commercialtrade, with merchandise representingover 22Oo/o of gross domestic product (GDP), accordingto a Credit Suisse researchreport. Typically,around 20o/o of those shipmentsare destinedfor US markeb, performance, to according growthhighlycorrelated to America's economic makingSingapore's wherea slumpin in recession, As such, Singapore is alreadytechnically the same research. growthinto negative for the secondquarterin a row. exportspushedquarterly territory gross domesticproduct(GDP) contracted 6.3% from the previousquarter.The Third-quarter Ministryof Tradeand Industryreviseddown its full-yeareconomicgrowthforecastdownfor the second time this year, recently trimming its projectionto "around 3%" from 4To to Sofo previously. pricesare on pace Meanwhile, inflation earlierthis year reacheda 26-yearhigh and consumer (MAS). Authority of Singapore 6% and 7% this year,according to the Monetary to risebetween will rise NationalTrade Union Congresshas (NTUC)warnedthat retrenchment Singapore's continues to deteriorate. nextyearas business the world'slargesfr abilityto maintain a position as a globalfinancialhub - already Singapore's privatebankingcenternext to Switzerland - will also likelyrequirea rethinkin the wake of the crisis,someanalysts say. The declinein stockmarketwealthacrossthe globemeansthe need if not years,ahead. and privatebankers will declinein the months, for wealthmanagers 6 Nov2008 Source:AsiaTimes,

7 tfd6: Ileglobalisation meansthe Gtoba*sation term:degrobatisation.

has popura y:,^new ecasnc meftdown Ttrre

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gE protectionism' of giobal high singapore's economy' singapore the in weaknesses ''tr exports certain sma*shareof the Th crisb has reveared for st"i", and Europe.-ilJ tii"u;"lrportr rro* singapore o"*r**lr"'in"-unit"o. uurn"i*r" r#t -.;,il;"i china to markel exports domestic. ot sing""po'e;r c#irs ro *rnafd;;;il low singapore's lurt'a7^i"r""r,t exports' :;;;pr,r" rs wr dornestic i"'"n"0"*1 l" i z. o1r 91"i"0"*u"ti" 3,.2i *:rdrrs oil. and;;;
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indicators economic 3007-49 s919-cted SinqaPore Table 2: U!(3!q Singapore: 2008 ?999 2007 tnnR 2009 zvv -1 . 3 1 . 8 8.2 -0.73 0.6 0 .6 6.6 2.1 2.2 neal COP (V 3.2 2 .3 2.2 2.3 7.8 lnflatirn rate 5,4 47.1 rale o/o 50.7 -24.2 43.2 -72.9 rr tv- I dur.vur 19.0 LJ"llTEfll' 20.2 28.9 1.1 -1. 6 acroun -2.6 Current -1 . 8 9.6 -7.1 - 5.C -0.3 -5.2 -5.7 1.6 -3.2 -0.8 2 .1 1 .45 1.41 1.51 0.64 0.55 10.9 35.8 45.1 91 . 5 1 6 6 .4 clatt stics.gov.ux f5t<11,.ltvv'uy Source:www's'r'[

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8 Figure 2: UK's and Singapore o/o change in House Prices UK Annual Vo Cha,ngein House Frices

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35----

Source:UrbanRedevelopment Authority,Singapore Table3: Gross DomesticProduct(GDP) and its components in UK and Sin of tota 2008 'A UK GDP(US$b) 1990 1561.2 113.1 By expenditure (o/o of ctal) Consumption 64 41 Government expenditure 11 22 Investment 17 31 Exports 29 234 lmports 32 215 Source: United Nations Statistics Division

9 Questions (a) (i)

Compare the change in house prices for UK and Singapore in 2008 in

Figure 2.

(ii) usingdatafromTable2, explain the change in housepricefor UK in 2008.

(b)

with the help of AD/AS diagram, explainhow changesin pricesof oil and househad affected UK'sequilibrium outputand pricelevelin 200g.

(c) (d)

Comment on the use of interest rateto promotehighereconomic growthin UK.

Using data, discusswhetherthe global financial crisis will have a greate impact on the UK or Singapore economy.

(e)

As a consultant economist, assessthe optionsthat you would presentto the singapore governmentas possible responsesto the challen$esposed by slowdown in worldtradeand foreigndirectinvestment.

End of Paper

Suqqested answers for PJC Prelim H2 Economics p'l e2 (a) (i) compare the change in house prices for UK and Singaporein 200g in t2l Figure2. House prices in both UK and singapore rose initiallyat a decreasing rate beforefallingat an increasing rate in 2008.(1) (lf studentsays houseprice rose initiallybeforefalling- 1 mark) House pricesin UK startedto fall earlier(beforefirst half of 2008)while it fell laterin Singapore(secondhatfof 2008) (1) Overall, P of housein UK fell in 2008whileit rosefor Singapore. (1)

(ii) Using data from Table 2, explainthe change in house price for UK in lzj 2008.
A fall in real GDP (as shown by the negative% change in real GDp), coupledwith a rise in unemployment rate(1), led to a fall in household income,as a result, a fall in demandfor houseswhichis a normal gooo, thusleadingto afaltin no@a.1t; (b) With the help of AD/AS diagram,explain how changesin prices of oil I4j and househad affected UK'sequilibrium outputand pricelevelin 2008. GPL

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1 markfor accuratelv labelled diagram that showscorrectshift of AD/AS

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Higherpriceof oil will lead to highercost of production as oil is an important rawmaterialfor production. Thus,AS shiftsleftwards. [1] Fall in price of houselead to a fall in wealthand henceAD shift leftwards. [1] Thefall in AS is greater thanfall in AD resulting in thefall in equilibrium output(shown by the negative realGDPgrowth) andrisein equilibrium price (rising inflation rate) in UKin 2008. [1] lf students onlyfocuson AD or AS correctly withaccurate diagram ) ma><2 marks 1 mark tor accurately labelled diagram that showsAD and AS shift Ieft (no marks deductedfor showingAD shiftmore than AS) 1 mark for change in AS due to higher oil price 1 mark for change in AD due to lower houseprice 1 mark for change in eqm output and price as shownin Table2.

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(c) Comment on the use of interest rate to promote higher economic t4I growthin UK. UK's centralbank loweredthe interestrate so as to reducethe cost of borrowing, thus helping to increase planned consumption and investment expenditure. This will bring about higher real national income via the multiplier effect, thus promoting higher economic growth.(2) However,the policymay be limitedbecauseof (i) interestinelasticity of C and l. Recessionin UK due to the financial and firms to be pessimistic and hencethey crisiswill cause households may not want to borrowto spend despitethe low interestrate. (ii) policy conflict. UK is currently facing high inflation and negative growth. Lower interestrate while stimulatingeconomicgrowthwill lead in UK. to higherAD, GPL thus worseningthe problemof inflation 2 marks for explaining how fall in interest rate works to promote growth and 2 marks forl limitation with the use of data. (only 1 mark for limitation without use ot data)
(d)

Using data, discusswhetherthe globalfinancialcrisis will have a t8I greater economy, impact on the UKor Singapore Explain how the olobal financialcrisis affect UK and Sinoapore economv financial crisishasledto a fall in worldtrade 6, the global FromExtract Thus,exports by UK and Singapore and FDIinflow to and investment. would fall. UK andSingapore Externaleffect of UK and Singapore will Externally, the currentand capitalaccount FDI have likelyto worsen.FromTable2, both UK and Singapore's In addition, by 51"/o and 70% respectively. fallen significantly hasfallensharply by almost28% account surplus current Singapore's account deficit has in 2008.On the otherhand,UK'scurrent to $50.7b Thiscouldpossibly due to a depreciation of the UK's reduced. actually price its exports cheaper andhence assuming in 2008making currency mayincrease. Furthermore, witha valueof UK exports elastic demand, imports - an income-induced expenditure income, fall in UK'snational will likely to fall as well hence improvingthe current account. Singapore'scurrent account may have worsened due to an rate of Singapore dollarvis-d-vis US$. of the exchange appreciation is morebadlyaffected effect,Singapore Thus,in termsof the external crisisdue to its openness to foreign tradeand by the globalfinancial investment. lnternaleffect (fallin netexports and FDI)ledto a lall in demand A fall in the external (AE) and hencevia the expenditure the level of plannedaggregate incomeof UK and Singapore wouldbe multiplier effect,real national full employment. A fall in realoutput below expected to fallif it operates for resources hence leading to a risein will leadto a lall in the demand

rate. As the level of aggregate demandfalls,demandunemployment pull inflation wouldlikelyfall. and financial the housing Furthermore, the financial crisisalso affected markets. The fall in the housingand stockpricesled to a fall in wealth to fall, thus which would cause domesticconsumption of households of UK and Singapore. causinga fall in the realoutputand employment Compare with Data Singaporeexperienceda sharper fall in our economicgrowth as her to onlya fall in 2009compared real GDP fell by a largerextentot 1.3Y" of the of 0.73/" for UK. This is once again due to greateropenness Singaporeeconomywhereby current accounttakes up almost20/" ot her GDP for both 2008 and 2009 whereasUK's currentaccountonly had risen of both countries takes up 1 to 3/" of GDP. Unemployment ratethan althoughUK experienced a greaterincreasein unemployment Singapore.This could be due to more effectivegovernmentpolicies (such as Job Credit Scheme and wage policies)carriedout by the As both UK and Singaporegovernmentto reduce unemployment. Singapore governments increased their government spending to stimulatethe economies, their budget balancehas worsened.ln the for the past 3 continuously case of UK, the budgetdeficithas increased yearsand this wouldlead to a risingnational debt burdenfor UK which fiscal has a healthier would affect its long term groMh. Singapore's position for the past and hence as it has been runninga budgetsurplus will be in a better positionto finance its deficitwithout increasingthe debt burden. as On the otherhand,the globalfinancial crisiscouldalso be beneficial With a fall in it led to a reductionin the inflationrate of both countries. globalincome,demandfor commodities such as oil and raw materials This helpedto lower fell causinga fall in price of these commodities. cost push inflation particularlyfor Singaporewhich relied heavily on imported for production. commodities Conclusion Singaporeappearedto be more badly affectedby the global financial crisis due to its greater openness of its economy.However,healthier fiscal budgetpositionput her in a better positionto adopt expansionary policyfor a longerperiod of time to counterthe negativeeffectsof the recession. Thus, her unemployment is less badlyaffectedthan UK.

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Marks Qescriptors For an answer that shows clear 6 - 8 marks comparisonof the full range of internal and external effects and supported by sound economicanalvsisand data. For an answer that compares a limited 4 - 5 marks range of internal and external effects and supported by appropriate economic analysisand some use of data.
Only compare either internal or external Max 4 marks effect For an answer that merely compares Max 4 marks theoretically but makes no use of data. For an answer with poor and inaccurate 1 - 3 marks economic analysis, weak or no comparison done between UK and Singaporeand makes little or no use of data.

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As a consultanteconomist,assess the optionsthat you would present [10 to the Singaporegovernmentas possibleresponsesto the challenqes I posed by slowdownin world trade and loreigndirectinvestment. ldentifv the challenoes SR Being a small and open economythat is highlydependent on world trade and foreign direct investment for groMh, the process of "deglobalisation" which led to a slowdownin world trade and foreign direct investment would pose problem to the short term economic growth or singapore.As X and FDI fell, AD fell and via the multiplier effect, NY fell by a larger extent.This would bring about a rise in unN as AD fell belowFN. LR In the LR, fall in FDI will causeAS to falland thus LT economic orowth will decline as well. The continuousfall in FDI and world trale will increase the threat of rising global protectionismwhich will affect Singapore's LT growthfurther. Weaknesses of the Sinqapore economv From the extract, the challengesfaced by singapore in sustaining economicgrowthare causedby her high exportdependence on United states and Europeratherthan china, her small domesticconsumption due to high levelsof home ownershipand relocation of her electronics firms to china due to the lack of large domestic electronicsfirms to anchorthe industryin Singapore. Thus, appropriate responses to the challenges posed by the slowdown in world trade and investment should include not only sr policies to deal with the problems of falling growth and employment in the sR but also the LT policies to deal with the fundamental weaknesses of the Singapore economy which may affect our LT economic growth.

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Recommendations for oolicyoptions Short-term measures Singapore can use expansionary fiscalpolicyto increase its G and C so as to overcome the fall in external demanddue to fall in X and FDl.The expansionaryFP should also be used to target at preventingrising unemployment caused by the global slowdown, e.g. the Job Credit Scheme.[explain briefly how the schemeworks) This will preventC from falling as workers are able to retain their jobs and face lesser uncertainty. In addition, depreciationof the exchange rate of the S$ should be adoptedto boost her exportcompetitiveness. This will lead to a rise in Qx and a fall in Qm. AssumingMarshall-Lerner condition is satisfied, net exportswill rise leadingto higherAD and actualeconomicgrowth. Evaluation Small size of k may limit the effectiveness of the expansionary Fp and ER as a demand-management tool to increase NY. Beinga small,open economywhere externaldemand makes up a large % of our AD, expansionary FP can at most minimisethe fall in AD and Ny. Our recovery is stillclosely tied to the recovery of the external economy. A depreciation of S$ is limitedas a weak ER will increase the priceof our impofis and may lead to higher inflation.Althoughthe fear of importedinflation is less imminent due to a weak globaldemand,it is stillimpossible to weakenthe ER of s$ by a largeextentgivenher high dependence on imports. Giventhe limitations policyoptionsshouldfocus of the ST measures, on long-termsupply measures to ensure that Singaporeis less susceptible to future externalinstability. Lono-term measures 1. Speed up ASEAN integration - by reducingtrade barriersbetween ASEAN members,this will promotegreatertrade among ASEAN members including Singapore, thus reducing the reliance of ASEAN and Singaporeon US and Europe. In addition,a more integrated ASEAN will pool their resourcesand offer a more attractivelocation for foreigndirect investment. For example,Singaporecan offer her efficientservicesector (e.g.financialand transportation sectors)for the foreign investmentto coordinate its primary and secondary production in Indonesia and Malaysia goods. and sell its finished Evaluation Greater competitionposed to the domestic industriesdue to the economicintegration which may bring about risingunemployment may deter ASEAN from integrating. Singapore will ultimately still benefit as its tertiary sectors complements well with the primary/secondary production of the other ASEANmembersbut this may not be true for the other ASEAN members as they might competewith each otheron primaryand secondary production. 2. Use supply-sidepolicies to promote the competitiveness of the electronics sector.From Table 2, Singaporehas been experiencing 10

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fall in productivity. This could lead to higheraveragecost and thus a fall in competitiveness of its electronicsexports.In addition,it will cause electronics firms to relocateto china where the cost is lower and the returnsto investmentare higher.ss-side policiescan also be used to subsidiseR&D effortsby the small domesticelectronics firms in singapore so as to promote higher demand and growth of our domeslic electronics firms, hence slowingdown the r-elocation of more electronics firms. Evaluation This is a long term measureand is subjectto willingness of the ygrler! to adapt to changing technorogyand skiils.'rn addition, R&D effortscany high risk and successriie is uncertain. 3- Diversifythe economy by creating new sector of groMh such as tourism, healthcare and education and reduce d;ependence on electronicsand financialwhich were badly affectedby the global slowdownaccordingto Extract5 and 6. The new sectorswill cater directly to china's risingconsumption as well so that we will reduce our dependence on US and Europe. Evaluation singapore will stiil be dependent on the externar sector as a slowdown in the global economy will still affect the demand for tourism,healthcare and educatign by foreigners. while promoting these othersectors,singaporeshouldstill continue to promoteour financialsectorsand electronics sectorswhich are our iwin-pillarof groMh. singapore should focus on ensuringthat our financial sectorsremainsoundthroughregulation of theirlending practice so that they will not be affected by global financialcrisis-.'Asfor her electronicssectors, it is necessaryto move up the value-added chain so that singaporecan avoid directcompetiiion with china and maintainher comparative advantagein the electronics sector. 4- Promote higher domestic consumption. This can be done by reducingthe level.ofhome.ownership throughencouraging rental of housinginstead.Alternatively, the governmentcan ensure that the price of housing remain affordlble through regurationto prevent speculationsuch as tax on capital gain so that home owners do not have to reduce their savings iubstantiallyto buy houses thus reducingthe amount of their consumption. Atcording to Figure 2, house prices in Singaporeare highryvoratire which may affect the wearthand destabilisethe economy.Thus, it may be necessaryfor the governmentto minimisethe volatilityof th6 housingpricesto ensurea more stableconsumption and giowth of the economy. Evaluation There are many benefitsof high rate of home ownershipcompared to rental housingsuch as lower rate of crime and greaier incentive by home ownersto maintaina cleanerenvironmentl From Figure2, housingprices are subjectto great volatilitydue to speculati6n and the.influx of foreignersand.foreigncapital to singapore. lt may be difficultto controlthe speculative activityand anyr=nappropriate and drasticmeasuresmay causethe "assetbubbleto bursi',wirichcoutd spark off a recessiondue to the negativewealth effect. (case of Japan)

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Overallevaluation The global economic crisis has revealed some fundamental weaknessesin the Singapore economy. Being small and open, Singaporeis extremelyvulnerableto the slowdownin world trade and investment.While it is necessary for Singaporeto promote higher there is a limit to how much it can increase domesticconsumption, domestic consumptiongiven its small populationand small domestic market.Hence,a betterpolicywould be to continueto promoteits trade and investment by making herself relevantto the rest of the world policiesto move and supply-side throughASEAN economicintegration growth her small and of promote the up the value-addedchain and overcomethe it be able to (SMEs). will Only then enterprises domestic posed by the fall in world trade and investment. challenges

Marks Level Descriptors At least two well explained and analysed 6-8 3
economicmeasuresto deal with the short term and long term challenges posed by the slowdown in trade and investment.Ansurer rb supported bv data. Two sufficiently well explained and analysed 4-5 economicmeasuresto deal with the challenges. However,answer may only focus on the short term challenges (e.9. use fiscal policy to stimulate growth of the economy) and not the long term challenges. Answer may also not be supportedby data. sufficiently Max 4 measure 1 well explained and analvsed ST/LT supportedbv data Weak and inaccurate explanation of 1 or 2 1-3 economicmeasuresto deal with the challenges. No or littleuse of data to supportanswer. A well developed evaluation to select best 2 of shortmeasure(which could be a combination term and long-term measures to deal with the challenoes) 1 An undeveloped evaluation

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