Briefly explain how exchange rate policy works in Singapore - the managed float.
Interest rate taker, supply and demand of loanable funds not enough to affect world interest rates.
An attempt to maintain domestic interest rates different from world interest rates will lead to huge short-term capital inflows, and large exchange rate changes that are not sustainable in the long term., The impossible trinity theorem
1. Factor inputs for production., Managing the exchange rate will create more certainty for firms and businesses employing imports as factors of production.
2. Consumer goods, many of which meeting basic needs of survival., Cost of living and citizens' welfare are affected because we import many primary products., Exchange rate policies allow Singapore to respond to supply side shocks directly.
Having a managed float exchange rate allows Singapore some control over fiscal policy., An attempt to increase output through G will not be crowded out completely by an appreciation of the exchange rate (that will lead to a fall in the current account)., Under a managed float exchange rate system, Singapore has fiscal autonomy in the sense that MAS is obliged to intervene in the exchange rate market to maintain the upper bound by purchasing more foreign assets (which increases the supply of SGD) and thus increasing the money supply in the economy. This will lead to a corresponding expansion in aggregate demand and output in the short-run (no crowding out effect because currency is not allowed to appreciate)
Part of a policy regime to attract FDI, Coupled with low corporate and capital gains tax, stable exchange rates help to attract foreign investment to Singapore., Reduce uncertainty for foreign investors, Increasing I can have both short run and long run benefits for Singapore's growth., Elaborate briefly using AD-AS framework if possible.
Possible stand: Quantitative easing and a global low interest rate environment is likely to create beneficial short term aggregate demand growth through investment in Singapore. However, in the long run, the rapid expansion of the interest sensitive sectors and the disincentive to save is likely to cause problems for our production capacity and supply side as well as create long run balance of payment problems when world interests rates rise in the future., Short term aggregate demand growth, 1b. A fall in world interest rates will encourage investment in Singapore, both FDI and domestic investment., The rise in money supply from MAS's policy, coupled with the low world interests rates means that investors can borrow and invest very cheaply., Stimulates investment in interest sensitive sectors such as residential investment., May use MEI framework to explain., Consumers are also able to borrow at lower interest rates, Stimulates consumption of automobiles or other goods that are credit dependent., 1a. A fall in world interest rates also mean that there will be a short-term capital inflow as rates in Singapore equilibrate to world interest rate levels., MAS intervenes to prevent fast appreciation by purchasing foreign assets with SGD (gradual and modest appreciation policy), **FYI(not needed in H2): can in the very short term prevent interest rates from falling with sterilisation, but not possible to keep doing it without international backlash for hoarding foreign reserves., May use demand supply diagram of FOREX market to explain., Net exports/ Current account stays in equilibrium, or falls only slightly., This results in a rise in money supply in Singapore., 2. The net impact of both of the above is that AD will increase in the short-run. Unemployment will fall. Illustrate with Diagram., 2010: 14.8% increase in real GDP growth., Back on the long run trend growth path: Closing the deflationary gap left by the recession in 2008., Likely to face inflation: Especially rising housing and car prices (interest sensitive sectors), No real impact on balance of payments in the short term: Capital account inflows are balanced by MAS's monetary transactions in the FOREX market, however, we can still expect a slight deterioration in the current account as import consumption rises due to rise in consumer income (income effect) and appreciation in the exchange rate (M-L condition), Long-run constraint, While investments are increased, we should bear in mind that these investments made under cheap money conditions might be less tenable in the long run when interest rates rises., Fall in world interest rates and domestic interest rates will discourage savings and lower marginal propensity to save in the long run., This will lower Singapore's natural savings rate and even though as a small and open economy our borrowing is not constrained by savings, as we can always borrow at the world interest rates, there will still be adverse impact on our long term balance of payments position. To finance our interests, profits and dividends payments to abroad from increased borrowing abroad, Singapore will need to increase export growth and reduce import consumption, both of which are likely to lower current domestic standard of living since we are so dependent on imports for growth., Eventually we will face inflation as bottlenecks appear in production., Wage increases will catch up with price increases., Profits will diminish., Output will shrink, Depict with diagram as we move to a long-run equilibrium.
Evaluation: While this is a comparative statics problem, we should also consider type of policy response taken by the government and how that might influence the outcomes., Encouraging productivity growth, moderating wage increases., Moderating expectations of the future, preventing over-optimism., Increasing CPF contributions to prevent a fall in savings rate?, Supply side investments, Retraining programmes, Infrastructure development, Increasing population growth, Developing new technology, Divert focus away from growth??
Think about the different channels that Singapore can possibly be affected., Think about 4 macroeconomic objectives.
Explain what is meant by quantitative easing and place it into the AD-AS model.
Explain briefly what low interests rates in the US and UK mean for an interest rate taker like Singapore.