Analysis Of The Economic Outlook Of Singapore Economics Essay

Analysis Of The Economic Outlook Of Singapore Economics Essay Introduction The February Issue of the Wall Street Journal has provided an article on the economic outlook of Singapore. The article contains many economic facts and concepts, which could be analysed and discussed. These concepts are derived from theory and provided in the context of Singaporean economy. Economic The first point raised by the authors of the article was that the economy of Singapore experienced recession during 2009 and started recovering in 2010 (Holmes and Venkat, 2010). We remain optimistic about Singapores outlook in 2010 and continue to expect the economy to return to positive growth of 5.1% in 2010, although we reiterate this years recovery is likely to be gradual and uneven (Holmes and Venkat, 2010, p.1). The Singapore economy can be well explained by the economic theory of business cycles. In general the theory suggests that capitalist society is unstable. Economic growth will never continue steadily but will be developing cyclically. Business Cycle Figure 1: Gross Domestic Product of Singapore in $million The theory distinguishes four major types of business cycles which are classified under Kitchin cycles, Juglar cycles, Kuznets cycles and Kondratiev cycles. The economy of Singapore reached its trough in 2009 in Figure 1. All of them have different time spans. Kitchin cycles last from 3 to 5 years (Kitchin, 1923). Juglar business cycle would last from 7 to 11 years. Kuznets cycles would last from 15 to 25 years (Glasner and Cooley, 1997). The longest business cycle is the one described by Kondratiev and Stolper (1935). It is rather considered a technological wave that has a span from 45 to 60 years. The year 2010 started with the contraction or growth phase of the business cycle. The analysis of historical indicators of GDP would allow for identifying at least four business cycles that developed in the period from 1960 to 2010. From Figure 1 it can be observed that the recent economic recession in Singapore was a part of the classic Juglar cycle that lasted from 2000 to 2010. It had a span of a little over than ten years and had a long phase of expansion with rather a short period of slowdown. Prior to this, there was a short Kitchin cycle that lasted from 1998 to 2000. During these three years, the economy went through a trough, recovery, peak and another slowdown. Inflation Rate Figure 2: Annual Inflation Rate in Singapore It is valid to account for the price level and real GDP of the country for the estimation of the business cycle. Real GDP is the nominal GDP deflated by the rate of inflation. High inflation would overestimate the value of GDP and economic growth would be presented higher than it really is. The changes in the annual inflation rate of Singapore are presented in Figure 2. During the years 1998 and 2009 when the economy of Singapore was experiencing recessions, the inflation rate was lower than during the phase of expansion. This observation indicates that inflation is higher when the economy is growing because businesses firstly tend to increase prices and then the output when additional demand appears. During the phase of slowdown, the situation is the opposite. Inflation rates tend to go down and nominal GDP approaches the value of real GDP. Aggregate Demand and Supply The expected economic expansion in Singapore in 2010 can also be explained by the theory of aggregate demand and supply. Generally, when demand (AD) increases, the prices rise and this in turn stimulates producers to increase supply or output (AD). As a result both nominal and real GDP would grow continuously. Figure 3: Aggregate Demand and Supply Model During the recession consumer demand for goods and services was down and therefore both the price level represented by inflation rate was lower and the real GDP declined. In the period of expansion that started in Singapore in 2010 (Holmes and Venkat, 2010), both the inflation and real gross domestic product are expected to increase according to the law of supply and demand. As consumers start spending more money on durable and non-durable goods and services, businesses will increase the prices and start expanding production, which would lead to the growth of total output in both real and nominal terms. This is demonstrated by the supply and demand model in the Figure 3. Price Level and Unemployment Rate It is interesting to note that there is also a relationship between the price level in the country and the unemployment rate. When the inflation (A to B) increases in the country, unemployment rates will go down because inflation is thought to be associated with economic growth and expansion. This relationship is explained by the economic concept of Phillips curve. Figure 4: Long Run Phillips Curve In the long run, however, the Phillips curve will be a vertical line (C) established at the natural rate of unemployment shown in Figure 4. In the case of Singapore, the short term Phillips curve was a valid model to represent the relationship between inflation and unemployment. By July 2009 the unemployment rate reached its maximum while the inflation rate declined, thus supporting the economic concept of Phillips curve shown in Figure 5 and Figure 6. Figure 5: Singapore Unemployment Rate Figure 6: Inflation Rate by Month Interest Rates It is valid to note that aggregate demand was stimulated during the recession by the central banks monetary policy. Without monetary stimulus, it would take much longer for consumers to start spending again and gain confidence in the future. The central bank started lowering the base lending rate (Trading Economics, 2010), which represented the short term interest rates in the country, in order to make it easier for consumers to borrow so that they could start spending more. The dynamics of the short term interest rates in Singapore is shown in the Figure 7. Figure 7: Singapore Interest Rates It is valid to note that in the pre recession period the country had already had rather low interest rates that ranged around 3%. In 2008, the central bank started reducing the overnight lending rate until it reached nearly 0% by 2010 (Trading Economics, 2010; Figure 7). Money Demand The article in the Wall Street Journal states that the expectation of contraction in the Singaporean economy and the 5.1% annual growth are feasible because the central bank does not plan to reduce the overnight lending rate too soon. As a result, there will be stimulus for borrowing, consumer spending and investing. Figure 8: Interest Rate Vs Money Supply The economic theory suggests that there is a direct relationship between the money supply and interest rates as shown in Figure 8. In fact, the interest rates are the price of money or the cost of money. When the cost increases, the demand for money will decrease. Similarly, when interest rates rise (I* to I**), the demand for money will fall. Both the consumers and businesses (S) will start borrowing less (Sloman, 2006). Keynesian View However, different school of economic thought offer different concepts on what would be an effective measure to stimulate the economy. For example, the Keynesian economic school argues that during the period of recession, it is essential to stimulate aggregate demand (AD). This has been seen in the case of Singapore when the central bank started stimulating aggregate demand by loose monetary policy in 2008 2010 (Trading Economics, 2010; Holmes and Venkat, 2010). Figure 9: Keynesian AS/AS Model The Keynesian view is that aggregate demand, if stimulated by monetary and fiscal policy, would eventually lead to the growth of the total output and aggregate supply. However, the neo classical school of economics offers a different solution. The neo economy states that the government should rather stimulate and tackle aggregate supply (Yte to Yrec) rather than demand. One of the measures that this school of economics proposes is to increase the money supply at a constant rate. The expansion of money supply is used to stimulate aggregate supply and economic expansion, thus reducing the volatility of the economy. The governments of developed countries in the European Union and the United States, however, continue to adhere to Keynesian measures of stimulating the economy and fighting recession. This has also been found in the case of Singapore (Holmes and Venkat, 2010). Since the recession had lasted only about a year in Singapore until the contraction and expansion started, Keynesian measures of stimulating the economic growth can be assessed as effective in spite of the criticism from the neo classical economic school. Conclusion It is valid to summarise the main arguments of the discussion of economic concepts in the context of Singapore that were based on the article in the February Issue of the Wall Street Journal. This article defended the position that the economy of Singapore will expand and achieve an impressive growth of up to 5.1% in 2010. This expectation has been discussed in the light of the economic theories of business cycles, the model of aggregate demand and supply and the theory of monetary policy and relationship between the interest rates, money supply and total output. From the standpoints of the theories and the fact that the central bank of Singapore does not plan to change its loose monetary policy, the economic expansion and growth of 5.1% are feasible and can be achieved.