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04 Nov Why is deflation a cause of concern?

Deflation is the sustained fall in general price level. Government will be more concerned with deflation if the deflation is caused by a fall in aggregate demand during economic recessions.

For Singapore, a worldwide recession is likely to cause a fall in exports and hence a fall in in aggregate demand. This will result in a leftward shift in the AD causing the general price level to fall and also a fall in the real GDP. As demand for goods and services fall, firms will cut back on their production and this will lead to a fall in the demand for labour. Producers will start to retrench workers and this will lead to a rise in cyclical unemployment. To the producers, lower prices also cause uncertainties to the firms and firms will start hold back on investment resulting in a further fall in aggregate demand and higher unemployment.

Consumers, on the other, will benefit from the lower prices in the short run. Lower prices will allow consumers to buy more goods and services. There will be redistribution of income caused by a fall in general price level. To the saver, their savings will also increase in real value. This will increase their material standard of living. Fixed income earners will now enjoy higher real income and hence higher purchasing power to consume.

Borrowers, on the other hand, will lose out as they have to repay their loans that have an increasing real value. However, in the long run, if prices continue to fall, consumers will hold back their consumption in anticipation of further fall in prices. This will result in firms cutting back on production and hence a fall in AD which results in higher unemployment. With lower or no income, consumers will cut back on consumption and this will result in a deflationary spiral which worsens the country’s economic growth and rising unemployment, thus penalizing consumers.

To the government, lower prices creates uncertainties and will affect consumers and investors’ confidence hence affecting the government’s ability to achieve macroeconomic objectives such as sustained economic growth and low unemployment. Foreign firms are less willing to invest in the country given the bleak outlook and this will affect the country’s capital account and balance of payments. Government also collects less tax revenue with falling incomes and profits and spend more on unemployment or welfare benefits which may end up worsening the budget balance. Lower tax revenue will also mean less expenditure on merit and public goods which will affect the citizens’ standard of living.

In conclusion, it is important for the government to identify the cause of deflation and assess the impact on the economy and finally implement appropriate policies to manage the economy when faced with deflation.

04 Nov Recession in Singapore

Economics News by JC Economics Tutor Anthony Fok
Topic: Recession in Singapore

The Covid-19 shock has affected Singapore’s domestic-oriented industries more severely than in past recessions, so economic recovery will likely take longer, the Monetary Authority of Singapore (MAS) said on Wednesday (Oct 28).

MAS said the pace of recovery is expected to moderate in the quarters ahead, as firms and households continue to be restrained by income loss and increased uncertainty, in turn holding back on investment and discretionary spending.

Downside risks to the growth outlook could also materialise if a resurgence in worldwide Covid-19 infections prompts more shutdowns and results in weaker-than-expected external demand, or if domestic labour market conditions deteriorate further and hamper a decisive pickup in consumer demand.

MAS reiterated the Government’s forecast for the economy to shrink by a record 5 per cent to 7 per cent this year because of the coronavirus pandemic. It said the economy will post above-trend growth for 2021 due to the effects of the low base in 2020.

“The path ahead remains clouded with uncertainty,” MAS warned in its twice-yearly macroeconomic review released on Wednesday.

“Some pockets of the economy, particularly the travel-related and some contact-intensive domestic services, are not expected to recover to pre-pandemic levels even by the end of next year.”

The Singapore economy registered its worst performance ever in the second quarter because of the circuit breaker measures, before experiencing a growth rebound in the July to September period when most of the movement curbs were relaxed.

The nation’s gross domestic product (GDP) contracted in the second quarter by 13.2 per cent on a quarter-on-quarter seasonally adjusted basis. The rebound in the third quarter saw the economy expanding by 7.9 per cent on the same measure.

While some of the sectors, mainly export-driven manufacturing, have since seen a pickup as the economy reopened, overall output is still some 7 per cent below pre-Covid-19 levels, MAS noted.

The rebound in the third quarter was also aided by the Government’s budgetary support measures. The impetus from fiscal support is likely to abate in the fourth quarter even as some measures such as the Jobs Support Scheme may persist.

MAS said that unlike the global financial crisis of 2008 when the resident unemployment rate returned to pre-crisis levels after six quarters, the recovery in employment is likely to be uneven and slow.

The central bank also said that the Covid-19 recession has been unprecedented in its intensity, having resulted in a cumulative 14 per cent decline in GDP from pre-crisis levels in the fourth quarter of 2019 to the trough in the second quarter of 2020. This compares with an average contraction of 6.1 per cent across the previous recessions.

Explaining why the recovery would take longer, MAS said the Covid-19 shock has disproportionately affected domestic-oriented and travel-related services in Singapore – such as food and beverage, retail, construction and aviation and hospitality – unlike previous recessions that were typically driven by the external-oriented manufacturing sector. These sectors have stronger interlinkages with firms and households within the domestic economy, thus amplifying the negative shock.

“Although the domestic-oriented sectors account for a smaller share of GDP compared to the external-oriented sectors, they generate significant indirect effects or negative spillovers on the economy through the production and consumption channels,” MAS said.

The loss in final demand in the worst-hit sectors generates ripple effects through supply chains, affecting other firms in the same or different industries. The drop in final demand also prompts companies in the worst-hit sectors to make a proportional cut in wages for their employees, thus weakening household consumption.

Thus, MAS said: “In all likelihood, the recovery will be more protracted than those in the past.”

For the global economy, the central bank expects the near-term rebound – supported by unprecedented fiscal and monetary policies – to fade into an incomplete recovery.

Questions for discussion during economics tuition classes:

1. Explain the causes of recession in Singapore.
2. Discuss the policies available to solve the recession problem in Singapore.