2021 H2 Economics Paper 2 Essay 5: Suggested Answers

The Monetary Authority of Singapore manages the Singapore dollar within a policy band and has historically favoured a modest and gradual appreciation to balance export competitiveness against price stability. Singapore uses the exchange rate, rather than the interest rate, as its main monetary policy tool.

Effect on inflation. Singapore lacks natural resources and imports most of its food and raw materials, which makes it susceptible to imported inflation. A stronger Singapore dollar makes imported goods cheaper in domestic terms, directly reducing imported inflation. It also lowers the cost of imported inputs used in production, which shifts the short run aggregate supply curve rightward from AS0 to AS1 and lowers the general price level from P0 to P1, easing cost push inflation. In addition, a stronger currency makes exports more expensive for foreign buyers, which can reduce export demand and, with the economy near full employment, lower aggregate demand and so reduce demand pull inflation. Because the appreciation is described as modest and gradual, these effects on the inflation rate are not expected to be large.

Effect on the current account. A stronger Singapore dollar makes exports more expensive on the global market, which may reduce export revenue as foreign buyers demand less, tending to worsen the current account. Working the other way, cheaper imported inputs lower production costs, which can keep export prices competitive despite the stronger currency and so cushion the loss of competitiveness. The overall effect on the current account is therefore likely to be limited, with the cheaper inputs partly offsetting the loss of competitiveness and the gradual pace preventing any sharp deterioration.