Section B: Case Study Global Economic Recession Extract 1: MAS makes drastic move to fight inflation The Monetary

Authority of Singapore (MAS) said yesterday it would allow an immediate jump in the value of the Singapore dollar by moving up the range in which it allowed the local currency to fluctuate. The currency move, which came amid a new surge in oil and commodity prices, surprised most economists, who expected the MAS to stick with the status quo, given the uncertain economic outlook. Indeed, the local currency rose 1.8 per cent to $1.3572 against the greenback yesterday. Experts now reckon that the Singdollar could reach $1.32 by year-end. OCBC Bank economist Selena Ling said the economy's surprisingly strong growth of 7.2 per cent in the first quarter probably gave the MAS 'comfort' to prioritise inflation over growth concerns. The MAS said in a statement that oil and food prices were likely to stay high for some time. 'Domestic cost pressures will persist due to short-term capacity constraints in certain segments of the economy,' it added. Inflation is expected to moderate in the latter half of the year, but experts believe policymakers should consider moves beyond currency strengthening. 'A stronger Singdollar cannot mitigate domestic sources of inflation like higher housing costs, wage costs and road usage costs,' said Standard Chartered Bank economist Alvin Liew. Source: The Straits Times, April 2008 Extract 2: IMF gives Singapore the thumbs-up The global recession brought about by the subprime crisis in the USA has sent world trade plunging since it took hold last November. This has been worsened by shifts in capital flows. The United Nations Conference on Trade and Development (UNCTAD) says worldwide FDI inflows shrank 21% in 2008. Responding to the worsening economic outlook, the Monetary Authority of Singapore (MAS) moved to a neutral exchange rate policy, where the currency neither appreciates nor depreciates, and then shifted down the band within which it trades in April this year. With inflation not a concern, Singapore's monetary policy is appropriate, the international Monetary Fund (IMF) report said, and should remain so for some time. But it added that Singapore should return to a policy of allowing the currency to strengthen gradually once economic recovery is 'well established'. The Government's $20.5 billion fiscal resilience package was described as 'timely, appropriately large and diversified'. $4.9 billion of that would be funded by the past reserves, which have never been drawn on. A key plank of the Budget is a novel $4.5billion Jobs Credit Scheme through which the Government will pay a portion of employers wage bill. To help Singaporeans

upgrade their skills so that they can stay employed or seek re-employment, the Government launched the Skills Programme for Upgrading and Resilience (SPUR) which provided higher course fee support for companies and individuals. But as risks remain on the horizon, the IMF said that the Government intended to undertake additional measures if the economic growth path proved to be weaker than expected. It also warned that removing the stimulus prematurely in the next Budget could undermine the confidence established by the stimulus package. The Government forecasts the economy to contract by between 4 and 6 per cent this year. Second-quarter GDP grew 20.7 per cent from the first, in strong signs that the economy is rebounding. The IMF predicts global economic activity to pick up modestly next year and Singapore's GDP to grow by a conservative 2.5 per cent. Over the medium term, trend growth is likely to be weaker than before the crisis, due to tighter credit, and as trade and production patterns shift to new markets. Sources: MOF January 2009, The Straits Times September 2009 Extract 3: UK Plans to increase borrowing to combat recession British Prime Minister Gordon Brown said Monday he planned to increase government spending by borrowing more to cushion the country's fall into recession. "The responsible course of action is borrowing for what is necessary now and for the longer term," Brown told business leaders and academics on Monday. Last week, official statistics showed Britain's economy contracted for the first time in 16 years in the third quarter between July and September, and the Bank of England is also expected to cut interest rates aggressively to help support growth. Brown and Bank of England Governor Mervyn King have predicted that next quarter's figures will also show economic contraction, warning that Britain is likely to be heading into a recession. But not everyone is convinced that increasing borrowing is the right course of action. In a letter to the Telegraph newspaper on Sunday, 16 leading economists argued that the plan could do more harm than good. "It is misguided for the government to believe that it knows how much specific sectors of the economy need to shrink and which will shrink 'too rapidly' in a recession," the economists said in the letter. "Thus the government cannot know how to use an expansion in expenditure that would not risk seriously misallocating resources." Source: The Associated Press, October 2008

Table 1: Singapore: Selected Economic Indicators 2006 GDP at 2000 market prices (% change) 8.7

2007 8.8

2008 1.8

2009 -1.3

Inflation (% change) Unemployment rate (%) Productivity growth (% change) Current account (US$bn) Current account balance (% of GDP) Inward FDI (US$bn) Government budget balance (% of GDP)

1.0 2.7 1.6 68.9 26.4 34.3 11.3

2.1 6.6 0.6 2.1 2.2 3.3 -0.8 -7.8 -8.7 71.1 50.7 47.1 28.9 20.2 19.0 35.8 16.8 10.9 12.1 9.6 -1,8 Source: www.singstats.gov.sg

Table 2: The UK: Selected Economic Indicators GDP at 2000 market prices (% change) Inflation (% change) Unemployment rate (%) Productivity growth (% change) Current account (US$bn) Current account balance (% of GDP) Inward FDI (US$bn) Government budget balance (% of GDP) 2006 2.8 2.3 5.4 2.4 -66.8 -3.4 175.4 -0.9 2007 2008 3.0 -0.7 2.8 3.9 5.4 5.6 2.3 0.5 -72.9 -43.2 -2.6 -1.7 186.4 91.5 -0.3 -3.5 Source: statistics.gov.uk 2009 -0.8 0.8 7.4 -2.4 -24.2 -1.1 45.7 -7.1

Table 3: Components of GDP in the UK and Singapore [% of total], 2008 UK Singapore Consumption 64 41 Government Expenditure 22 11 Investment 17 31 Exports 29 234 Imports 32 215 Source: United Nations Statistic Division Answer: (a) Compare the trends of general price level between Singapore and the UK between 2006 and 2009. Prices are generally increasing in both countries (1). Prices are increasing at an increasing rate from 2006-08 and increasing at a decreasing rate in 2009. (1) or The increase in prices is more significant in Singapore than in the UK. . Version 1: Explain how the change in exchange rate policy as described in Extract 1 will help Singapore combat inflation. imported inflation falls (2m) cost of imported raw materials fall (SR)AS increases lower cost-push [imported] inflation (1m) Appreciation of S$ price of imports cheaper in S$, price of exports more expensive in foreign currencies [Assuming Marshall-Lerner condition holds, that [2]

(b)

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is, sum of PED of X and M>1] net X revenue falls AD falls lower demand pull inflation (1m) Version 2: To what extent would the change in exchange rate policy as described in Extract 1 help Singapore combat inflation? The above plus: NO: However, a stronger S$ would not be able to address other sources of inflation such as higher housing costs, wage costs and road usage costs. (1m) Conclusion: Overall, given that Singapore is reliant on trade as a major engine of growth and imports for its necessities, exchange rate would help address the major sources of inflation. However, it ought to be complemented by supply-side policies that help to improve infrastructure, increase productivity, lower unit costs etc. (1m) (ci) Describe the trend of productivity in Singapore as shown in Table 1. Productivity is increasing in 2006, but falling at an increasing rate from 2007-2009. To what extent can productivity growth explain the deteriorating balance of (cii) payment of Singapore? Yes (3m) - Fall in productivity growth higher unit cost of production [assuming wages remain constant or do not fall as much] SRAS curve shifts left higher prices domestic goods are less competitive PED of X >1 current account worsens - Domestic goods are dearer compared to imports Consumers switch from domestic goods to importsM rises current account worsens - Fall in productivity growth attracts less FDI and local companies relocate to more cost-competitive countries capital and financial balance worsens No (3m) - Higher inflation rates due to reasons other than fall in productivity levels, e.g. higher imported inflation from higher oil and commodities fall in current account balance - Higher oil and commodity prices PED<1 Less than proportionate fall in Qd import expenditure increases - Economic crisis in 2008 and 2009 lower foreign income fall in demand for our exports fall in current account balance in 2008/ current account balance in 2009 largely unchanged. - Worsening global economic outlook withdrawal of hot money and FDI capital and financial balance worsens While lower productivity might have some impact on Singapores competitiveness as an exporter and FDI destination, a bigger reason could be the global recession.

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[2] [6]

(d)

Using the data provided, discuss whether the global recession will have a greater impact on the UK or Singapore economy. Explain how the global financial crisis affect UK and Singapore economy From Extract 1, the global financial crisis has led to a fall in world trade and investment. With falling incomes and worsening economic outlook, consumers would cut back on expenditures and increase precautionary savings. Furthermore, with higher degree of uncertainty, firms will also have less incentive to increase productive capacity overseas. Thus, exports revenue and FDI inflow to UK and Singapore would fall. From Tables 1 and 2, both UK and Singapores FDI have fallen significantly. In addition, Singapores current account surplus has fallen sharply in 2008. On the other hand, UKs current account deficit has actually reduced. With the fall in UKs national income, imports an income-induced expenditure will likely to fall as well hence improving the current account. A fall in the external demand (fall in net exports and FDI) led to a fall in the level of planned aggregate expenditure (AE) and hence via the multiplier effect, real national income would be expected to fall. A fall in real output will lead to a fall in the demand for factors of production amd hence leading to a rise in unemployment rate. As the level of aggregate demand falls, demand-pull inflation would likely fall. Compare with Data Singapore experienced a sharper fall in our economic growth as her real GDP fell by a larger extent of 1.3% in 2009 compared to only a fall of 0.7% for UK. This is due to greater openness of the Singapore economy whereby current account takes up almost 20% of her GDP for both 2008 and 2009 whereas UKs current account only takes up 1 to 3% of GDP. Table 3 also shows that export and investment take up a much larger proportion of GDP in Singapore than the UK. Unemployment of both countries had risen although UK experienced a greater increase in unemployment rate than Singapore. This could be due to more effective government policies (such as Job Credit Scheme from Extract 2) carried out by the Singapore government to reduce unemployment. As both UK and Singapore governments increased their government spending to stimulate the economies, their budget balance has worsened. In the case of UK, the budget deficit has increased continuously for the past 3 years and this would lead to a rising national debt burden for UK which would affect its long term growth. Singapores has a healthier fiscal position as it has been running a budget surplus for the past and hence will be in a better position to finance its deficit without increasing the debt burden. On the other hand, the global financial crisis could also be beneficial as it led to a reduction in the inflation rate of both countries. Falling external demand would exert downward pressure on general price levels. Furthermore, with a fall in global income, global demand for commodities such as oil and raw materials fell causing a fall in price of these commodities. This helped to lower cost push inflation particularly for Singapore which relied heavily on imported commodities for

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production. Conclusion Singapore appeared to be more badly affected by the global financial crisis due to its greater openness of its economy. However, healthier budget position put her in a better position to adopt expansionary fiscal policy for a longer period of time to counter the negative effects of the recession. Thus, her unemployment is less badly affected than UK. Level L3 Descriptors For an answer that shows clear comparison of a wide range of effects and supported by sound economic analysis and data. Marks 68

L2

For an answer that compares a limited range of 4 5 effects and supported by appropriate economic analysis and some use of data. For an answer that merely compares theoretically but makes no use of data. Max 4

L1

For an answer with poor and inaccurate economic 1 3 analysis, weak or no comparison done between UK and Singapore and makes little or no use of data.

(e)

Using both the case study and your own relevant knowledge, compare and evaluate two choices of policies adopted by Singapore and the UK in response to the recession. Use of Fiscal Policy: Similarities Similar problems caused by the global downturn suggest both countries should be using a standard set of tools i.e. expansionary FP. Both Singapore and UK: Increase G increase AD increase NY via k. Differences -Spore has greater ability to use G due to her huge past reserves [Extract 1] whereas UK budget balance is already in a persistent deficit [Table 2]. Borrowing will also lead to higher demand for credit, crowding out investment and consumption. This would also lead to a misallocation of resources since the

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government may not know which sector to expand. [Extract 3]. -The effectiveness of fiscal policy to stimulate AD will be limited in Singapore compared to that in the UK. Based on Table 3, consumption takes up a smaller portion of GDP while imports take up a significantly larger portion of GDP in Singapore. This may suggest larger MPS and MPM respectively. As such, with a smaller multiplier, GDP will increase less significantly in Singapore than in the UK with the same amount of injection. - The fiscal stimulus in Singapore appears to focus on 1) SS-side affects G on SPUR productivity increase increase in potential growth 2) Minimizing the impact of the recession G on Jobs Credit Scheme keeping retrenchment/demand-deficient unemployment in check by lightening the wage burden on firms. Use of Monetary Policy: Differences - Singapore and UK uses different set of monetary tools to deal with recession. Singapore: Depreciation of S$ S$ falls X cheaper in foreign currency, M more expensive in S$ PED of X and M > 1 X revenue likely to increase and M expenditure likely to fall NX revenue increases This may be effective in Singapore as external demand is her major engine of growth given her small domestic market. However, Limitations of exchange rate policy (any one): - In a global recession, purchasing power of our major trading partners remains low. This, coupled with worsening economic outlook, would mean that lower prices would not be effective in increasing export demand significantly, especially given that the demand of Singapores exports tend to be income elastic. - Higher import prices would mean that cost of production is higher for Singapores exports, which tend to have high import content. UK: Lowers interest rate Lower r cost of borrowing falls rate of returns to an investment (MEI) increases/ interest returns to savings falls I and C increases AD increases GDP increases via k This may be effective in the UK given its large domestic market. However, Limitations of interest rate policy: UK poor economic outlook implies an interest inelastic MEI, plus poor consumers confidence so C also interest inelastic. Hence lowering of interest rates will have little effect on raising I and hence AD.

Take a stand With external sector/ consumer and investors sentiments remaining weak due to global recession, depreciation in S$ and fall in interest rate may be limited in stimulating growth. Fiscal policy seems to be most effective in the short term as increase in G is a direct injection into the economy. Singapore is in a better position to increase G due to large reserves whereas UK has to resort to borrowing which may create more problems in the future. While G spending is not likely to increase AD considerably in Singapore, it may be effective to cushion the negative impact of the global recession, such as unemployment. L2 For an answer that analyses the similarities and differences in choice of growth policies between the UK and Singapore. Answer also includes explanation of the limitations of the policies chosen. Explanation of measures without comparison. Through evaluation of policies. E.g. discuss the appropriateness of policies to a small and open economy compared to a large and less open economy/ take a stand on the effectiveness of policies in Singapore compared to UK. Brief evaluation of policies. 4-6

L1 E2

1-3 3-4

E1

1-2