Tuesday, April 22, 2008

Tackling inflation needs multiple measures

The Business Times 11/04/2008

STRONGER-THAN-EXPECTED economic growth has given more room for the Monetary Authority of Singapore (MAS) to tighten monetary policy to fight inflation (through strengthening the Singapore dollar), but that luxury may not be afforded by the central bank going into the second half of the year.

Singapore's economy grew 7.2 per cent in the first quarter, beating economists' expectations. In its monetary policy statement announced alongside the flash growth estimates, the MAS said that it has decided on an "upward shift" in the range in which it manages the Singapore currency. "An upward shift of the policy band will help to moderate inflation going forward while providing for sustainable growth in the economy," the central bank said in its twice-yearly review.

"Inflation is expected to remain high until the middle of the year before easing in the second half," it added. The move, unexpected by the market, sent the Singapore dollar to a record high against the US currency. The MAS uses the Singapore dollar exchange rate as its main inflation management tool. A stronger currency helps reduce the surging cost of imported food, which Singapore is dependent on.

According to official estimates, inflation is set to hit 4.5-5.5 per cent this year, but many private sector forecasts exceed this. That said, the Singapore dollar exchange rate remains a blunt tool to control inflation. Allowing the currency to appreciate, while cheapening imports, also has the effect of making exports less competitive. This may not be an issue when economic growth comes in as strong as the first-quarter numbers, but could pose a policy challenge should growth taper off going forward.

The key question remains the extent, and the intensity, of the expected US slowdown in the wake of the sub-prime crisis, and the impact this will have on the Singapore economy. Economic growth in Singapore could be as little as 3 per cent this year if the US economy tanks, according to an earlier forecast from economists at the Nanyang Technological University (NTU), although growth is expected to stay at a decent 5.5 per cent should the US escape a full-blown recession – within the official 4-6 per cent forecast range. Giving its assessment yesterday, the MAS said that the economy is likely to grow at a "more moderate pace" while inflationary pressures remain high.

For the moment, the MAS should have enough flexibility to target inflation without worrying about growth. This might change, however, should growth come under greater threat in the later part of the year. In this context, more direct ways to tackle inflation – or at least, its impact – are needed.

The recent move to set aside $1 million to help needy Singaporeans cope with the rising cost of living is welcome, as is the indication that increases in government charges would be postponed. More of such measures will probably be needed to complement the use of the exchange rate in the fight against inflation.

Questions
  1. With the aid of a diagram, explain how monetary policy works in addressing the current problem of inflation in Singapore.
  2. Evaluate the effectiveness of Singapore's monetary policy in fighting inflation and ensuring long-term growth of the economy.
  3. Suggest other policies that can be used to complement monetary policy in controlling inflation for the Singapore economy.