The scourge of inflation
Friday, 20 June 2008, 7:48 am |
Farquhar
An old foe rears its head
Singapore has largely enjoyed success in curbing inflation since the country’s inception in 1965.
There is usually thought to be a trade-off between inflation and employment (and by extension economic growth) - disclaimers have to be made for the stagflation of the 1970s and the low inflation and strong growth of the 1990s-2000s that the world experienced - but Singapore has actually managed to tame this beast quite well, enjoying both high economic growth and low inflation since independence with few exceptions.
The Monetary Authority of Singapore’s (MAS) statistics show that from 1965-1998 real GDP growth averaged 8.7% a year with inflation running at 3.3%. This compares well with an average inflation of 8% in developing countries, and 6% in developed countries over the same period. Inflation dropped to around 2% per annum in the 1990s-2000s even while growth remained robust.
This state of affairs has principally been due to the government’s approach of vigorous intervention in the macro-economy. The MAS - Singapore’s central bank - has been at the vanguard of the effort to control inflation, largely through exchange rate targeting necessitated by the fact that the Singapore dollar is pegged within a certain exchange rate band to a basket of currencies. To complement MAS’ efforts, the government employs a formidable range of fiscal weapons, such as its control over CPF contribution rates and land sales.
So far that combination has proven successful in seeing Singapore through tricky bouts of inflation such as the stagflation of the 1970s and the oil shock of the early 1980s with little impact on growth. Singaporeans have since grown used to a benign rate of inflation, helped in large measure by globalisation against a backdrop of a stable external environment.
That explains why Singaporeans are somewhat unaccustomed to the resurgence of inflation, which began gathering steam from September 2007 onwards. It reached 7.5% on a year by year basis in April 2008, and looks set to stay high for awhile. On top of that, inflation is starting to look rather troublingly erratic, with the monthly change hitting 1.2% and reversing the previous month’s drop of 0.1%.
Some inflation is necessary to grease the economy, but an unstable rate of inflation brings unpalatable ills - distorted price signals, uncertainty in the macro-environment, a possible wage-price spiral and the arbitrary redistribution of income. There are signs that all these are beginning to materialise.
The more immediate effect is that inflationary pressures are being disproportionately borne by lower income Singaporeans, since basic commodities such as foodstuff (whose prices have been rising more than many other goods) make up a larger proportion of what their expenditure are compared with more affluent Singaporeans. This might exacerbate existing inequities in what is already a highly unequal society.
Inflation could soon start to eat into wages and savings, though a recent report from the Ministry of Manpower (MOM) tried to reassure Singaporeans that wage gains still kept ahead of inflation in most jobs. But the arbitrary redistribution effected by inflation might have already begun to bite - MOM’s report showed that in the first quarter of 2008 real earnings fell in manufacturing and transport even though they registered productivity gains compared with other jobs that didn’t.
What’s more worrying is the possibility of a wage-price spiral. Wages have risen by 11% in the first quarter of 2008, their biggest rise in a decade, compared with 4.3% in the previous quarter and 5.5% in the first quarter of 2007, but real growth was only 3.6%, lower than the 5% of the first quarter of 2007. Furthermore, labour productivity actually contracted by 2.8% in the first quarter of this year following a 3.7% decline in the preceding quarter, which makes the huge leap in nominal wages a bit hard to justify.
There are two further longer term effects if inflation continues at this rate. Singaporeans might find their savings eroded given that CPF rate of returns aren’t keeping pace. Additionally, the uncertainty engendered by inflation would probably start to worry investors.
Let slip the dogs of war
All these indicate that the government has a potentially big problem with inflation on its hands. Yet it seems to be more fixated on the problem of growth instead. Most analysts forecast that Singapore’s GDP growth will ease to 4-6% this year. This will be more in line with the country’s long term growth potential, according to MAS, but it could still result in the economy shedding jobs.
The government is understandably worried about the probable economic slowdown and the effect that this will have on employment. But it is at risk of not focusing enough on the danger posed by inflation.
This is in part because it blames the current burst of inflation mostly on external factors. This is true to a large extent, since global oil, food and other commodity prices have escalated dramatically over the past year and a good deal of Singapore’s inflation is usually imported due to its reliance on the outside world to provide these goods.
Yet this understates the effect of domestic inflationary pressures, some of which are caused by the government’s policies. For example, MAS estimated that the Goods and Services Tax hike might have contributed up to 1.4% to inflation in the second half of 2007 and first quarter of 2008. The current property boom - fuelled partially by big scale infrastructure investments and construction of the integrated resorts - has pushed up housing costs; measures to be introduced next year to revise the annual values of most properties will push housing costs up even further1. And while the government’s liberal immigration policy has helped to keep wage costs somewhat in check, it has added to pressures in the residential market as well as to transport costs. Meanwhile, tightening conditions in the labour and commercial property markets are contributing to rising business and wage costs.
It also understates the possible effects on inflationary expectations, which could have a longer-term effect on inflation even after the current pressures have eased. One paper put current expectations at 1.5% per annum, due in large part to MAS’ credibility in controlling inflation as well as its efforts in improving transparency in its conduct of monetary policy2. However, a prolonged period of high inflation could dent these credentials and affix inflationary expectations at a higher level.
One problem is that MAS faces potential conflicts of interest. Its job is to focus on price stability, but the problem is that its weapon of choice - the exchange rate for the Singapore dollar - affects the economy’s export competitiveness and growth as well. Hence, it has always kept one eye on the latter even as it has attempted to navigate the problem of price stability.
This might not have been an issue in the past where choices were more clear-cut, but it could affect its ability to fight inflation in a situation where it might really have to choose between inflation and growth, which the present circumstances seem to be leading into. This is not helped by a government (which controls MAS) engrossed with maintaining growth. Furthermore, exchange rate policy might no longer be the panacea that the government thought it was, as some economists have argued (and which the present situation seems to prove) that it is ineffective in curtailing domestic inflation.
One possible way forward is to fortify MAS’ independence from the government even further (it is admittedly already quite autonomous) and to give it a strict inflation target to aim at. This might bolster MAS’ credibility and lower the costs of containing inflation. Accountability can still be retained by having the government set the inflation target. MAS might also shift some of its focus back to managing money supply and interest rates, a strategy it had abandoned in the 1980s in favour of focusing only on exchange rate policies. Another solution is to make the inflation-growth trade-off easier to take: build a decent social safety net so that MAS or the government do not have to worry too much about the consequences of tackling inflation.
But even without monetary policy the government still retains a great deal of fiscal leverage. It needs to deploy more administrative measures to ease the urgent problem of domestic inflation. So far it has tread gingerly around this and has even gone the wrong way, such as its untimely announcement about raising ERP charges. It might come to rue this reticence if the scourge of inflation ends up taking hold.
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1 DBS Group Research, “Singapore: Higher inflation yet to come” (5th December 2007)
2 Khor Hoe Ee and Saktiandi Supaat, “The anchoring of inflationary expectations in Singapore” (Bank of International Settlement papers No. 35, 2008)
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Cartoon by My Sketchbook.
Who is Farquhar? Read about him here.
He can be reached at : farquhar.toc@gmail.com
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Just one line on money supply? It’s not fashionable to have a money supply policy nowadays, but it’s surely very instructive to track how it’s been moving in the past few years. That will provide a lot more insight on the actual causes of inflation.
Dear Cx,
Thanks for pointing that out. According to MAS’ data, broad money supply grew at a robust rate of about 4% in 2007 (and 2-3% the year before), though MAS thought that this was due more to Singapore’s GDP growth spurring demand for money rather than low interest rates imported from the US.
But there’re some sizable gaps in the supposed correlation between GDP growth and money supply, indicating that there’s room for interest rates to play a role.
!0% inflation at year end? Not possible? Oil per barrel $140 not possible but has been breached. There are talks of $500/barrel oil in the future. As long as liquid fuel such as oil which is used to power transportation, machinery and equipments remains high, inflation will never receed. There are also more drought, flood and natural disasters this year than any other years. These affected farmlands and water supplies. All needed to irrigate farmlands and create arable lands for farming. Without more bad luck, farm production in wheat, corn and soya has reduced dramatically. I even told my wife back one year ago that rice will have a super spike in 2008 due to poor harvest and huge demands and it happens. I wasnt even surprised when rice keeps shooting up.
The EARTH is getting sick. Therefore whatever the gahmen says of inflation dying off at the year end is rubbish to my ears. Good enough to fool sheeps only.
I believe inflation will eventually hit more than 10% and drops only mid next year.
FG
“The EARTH is getting sick. Therefore whatever the gahmen says of inflation dying off at the year end is rubbish to my ears.”
Because the gahmen says rhetoric so that to justify whatever price they want to rise eg ERP entry cost, their very millions dollar salary, admin cost, food cost, as long as getting more money from public
“Ministry of Manpower (MOM) tried to reassure Singaporeans that wage gains still kept ahead of inflation in most jobs. But the arbitrary redistribution effected by inflation might have already begun to bite.”
What does MOM know - that they cannot solve everything. That, everyone knows. “wage gains still kept ahead of inflation in most jobs” - how ? out of thin air ? What is their definition of most jobs ? maybe their kind of jobs.
This inflation on commodities (and the spillover effect on other goods / services)is the sudden shift of attention from other areas (with weak fundamental) to commodities as a hedge by major players globally. Commodities always have their fundamental intrinsic value as it provides the basic requirements & needs of human beings.
The problem with the current global system is that people or institutions who do not have the real need to take delivery of commodities are given so much right / power to deal with them, hence creating this speculative demand (many times over the real demand) & hence the accompanying inflationary effect.
While major players always have the big insitutional resources to hedge it and in turn create this upward spiral effect, common people (with their own small resources individually) with real needs are like sitting ducks waiting to be sucked in by this inflating price effect.
Of course, the government needs to help - especially those low income and poor people as no amount of effort on their own can solve this serious inflationary problem which was not caused by them in the first place.
We have been paying market price for everything. Houses to food! No subsidy from gahmen. GST increases, ERP and fuel price hikes…cost of living is very inflated. Ultra low interest rates in bank accounts and slow wage growth for many are adding greater burden to all singaporeans. Even our jobs are snatched by foreigners. What kind of gahmen do we have? A heartless one?
It is also important to consider the distribution of real GDP growth throughout the population. While Sg’s real growth was ~7% last year, the actual distribution of growth from the lower to higher income percentile varies considerably. One also has to take into account the distribution of growth between the domestic and external economies. Considering the extent of our external economy, it maybe possible to conclude that growth in the domestic sector is markably less than 7%; and considering the relatively high gini coefficent (income-inequality index), real growth for the lower income percentile will definetly be even lower, and at worse, negative.
The NTUC Chief just raised the spectre of stagflation!
“Ministry of Manpower (MOM) tried to reassure Singaporeans that wage gains still kept ahead of inflation in most jobs.
Is the above mention statements justified to the REALITY now??. What level of living does it apply to? Lower Class, Medium Class or the High Class?.
Does any company will increase wages for employees in this situation or recommend Cost Saving Programmes to cut on their expenses??
Think it this way, if you are a Boss of company and your company is making $$. in this difficuit time.Will you go for a pay rise or cost cutting to survive. Even worst, some bosses may use this inflation as an excuse to forego pay rise.
This is what the gaham has mould out in every Singaporean to be independent on own survival or another word…..SELFISH.
Now every single things has increase in price$$$. It’s to believe that the increase will be going on in the world market and this will pass on without fail.
What the gahman can help to ease???
GST Offset??Dividend Bonus??….How much this can help or how many times the gaham can give??/
I , myself has some little saving which will soon be exhuasted due to this difficuit times………..What can the gahman do…..??
Give you loan or you loan from others??? But the gahman has been keeping a big share of our $$$ in CPF for Housing and Retirement……..
Now the truth is that, you are struggling in this time now daily…..Can’t even think till retirement in future time. What is the use then???
If the worries for the gahman is citizens may not have enough for Housing or retirement. Why not come out with a benchmark to determine the abilities of each Housing and give out certain percentage of the CPF as a relieve in this difficuit time. Morever this is OUR $$$$$$$$. It’s can’t be spend till retirement and what is the use.
Example a $60k in CPF to give out 8% is only $4.8k. This will definately better than all those Bonuses given out by the gahman. With tis move will be greatful and increase the gahman popularity…………..
My own view…….Thank You……..
Given the choices (and without large scale government intervention and err…doom to fail price control), exchange rate policy would have been the best way to handle this. Increasing interest rate to deflate the rest of the economy in the wake of external shock just isn’t going to help anyone. Through a steady supply of migrant worker, Singapore wage growth is well under control, increasing interest rate would serve no purpose other than to increase unemployment, and perhaps deflate the prices of things of the non essential (and hence keeping the CPI on target) but gives zero help to those who still need to buy food and oil that singapore does not produce.
As for administrative measures, I am not sure what you are proposing but the last thing Singapore needs now is wage demands going out of control and create a feedback into inflation expecation.
You right mention that the flip side of higher FX Rate is the competitiveness in exporting. This is not necessarily a bad thing. Staying competitve through FX manipulation has never been a long term solution.
Many Singaporean company remains hugely hierachical and pocket of inefficiencies remain and this may be an opportunity to make them to make creative changes in order to remain competitive.