Econs PM session 24/07/18

A levels 2010 Q4:

The recent worldwide recession caused many governments to re-assess their use of fiscal
policy in order to stimulate their stagnating economies.
a. Explain what could reduce the effectiveness of fiscal policy as a stimulus to the
Singapore economy. (10)
b. Assess alternative policies that might be more appropriate in managing the Singapore
economy when faced with a worldwide recession. (15)

a. Fiscal policy is a demand management tool that can be used to influence the level of AD in an
economy. Singapore uses the expansionary fiscal policy which refers to when there is an
increase in government expenditure(G) and a reduction of taxes(T) that can increase AD and
real national income stimulating growth in the economy. The effectiveness of the fiscal policy
however can be affected by Singapore’s small multiplier and consumer and investor
confidence as Singapore is highly reliant on export and import.

Expansionary fiscal policy can bring about a multiplied increase in national income through
the multiplier process (K) but in Singapore, we are affected as we have a small K. The
multiplier process refers to when there is an increase in autonomous spending (C,GI,X-M)that
leads to bigger increase in national income. Therefore, when G increases, GDP increases via
the multiplier effect. For example, SG government spends 1 million dollars on infrastructure,
the money for the construction given to the contractors will then generate more income where
out of the 1 million, they attain 500,000 thousand dollars as salary. This will then turn into
higher purchasing power which will then be used to buy more goods and services. Therefore,
as the money is being passed down, national income increases. But due to Singapore’s small
multiplier size, given by k=1/MPW and her large marginal propensity to withdraw (MPW=
MPS+MPT) for example, CPF central provident fund. Therefore, any increase in G, it will not
cause a huge effect and is limited unless it is sufficiently large enough. Hence, it may cause
the government to strain on government budget and may drain the nation’s reserves over
time and this affects the fiscal policy where in the long run, it may become obsolete as it
becomes unsustainable and the government may even go into debt and will need to borrow
from central banks which impedes economic growth even further.

In conclusion, fiscal policy as a stimulus to the Singapore economy might not be the most
effective due to our small multiplier, large MPW and heavy reliance on exports. Therefore, we
will not be able to sustain fiscal policy and we may thus choose to use other policies instead
as well such as adding a supply side slant to our expansionary fiscal policy to make it easier
for economic growth in the long run.

b. A recession refers to when there is a fall in GDP for six months. Given the world-wide
recession, Singapore is definitely affected as we are heavily reliant on net export revenue.
This affects no only our healthy BOP but also our economic growth as well as unemployment.
Therefore, when faced with such an issue, instead of adopting only expansionary fiscal policy,
Singapore may choose to adopt supply side policies or depreciate its currency.

The exchange rate policy might be more appropriate in managing the Singapore economy
when faced with a world-wide recession. By depreciating the currency, price of domestic
goods decreases and exports in foreign currency will be relatively lower while the price of
imports will be relatively higher in domestic currency. This is assuming that the Marshall-
Lerner’s condition holds. Therefore net exports will rise where X rises proportionately than M
decrease. This causes AD to shift to the left causing actual growth and a reduction in cylical
unN. However, Singapore may choose to take a zero- appreciation or a gradual appreciation
approach instead due to the risk of imported inflation which will increase cost of production
and impede our economic growth. Therefore, the depreciating her currency may not be as
effective or sustainable in the long run.
The supply side policy might be more appropriate in managing the Singapore economy when faced
with a world-wide recession. Supply Side Policies are policies are aimed at increasing Aggregate
Supply (AS), a shift from left to right due to a change in quality, quantity of the factors of production or
an increase in technology. For instance, Singapore created something called skills future to help train
workers and to upgrade their skills bringing about a decrease in structural unemployment as well as
attracting investors to invest in the Singapore therefore bringing about potential economic growth in
the long run. Furthermore, with the new water technology that Singapore uses, we are able to
produce our own NEWater via reverse osmosis technology and we can thus even help Malaysia to
process its waters and to sell it back to them, bringing about more revenue from external sources.
However supply side polices are difficult to implement and may take a long time to produce results
unlike fiscal policy which is a demand- side policy that has more immediate effects on the economy.

In conclusion, fiscal policy, exchange rate and supply side policies are effective in managing the
economy of Singapore during a world-wide recession as it aims to help improve the economy but
because during a world-wide recession, there are not just one issue that arises such as the rise of
unemployment due to retrenchment but numerous problems exist and therefore, we need to apply a
combination of policies to achieve our macroeconomic aims

A Levels 2015 Q5

During the recent world-wide recession many European countries chose low interest rates as
a monetary policy approach rather than adopting demand-led fiscal policy stimulation. At the
same time, with most of these countries’ governments introducing large cuts in government
expenditure in order to reduce their budget deficits, a fiscal contraction actually resulted.

Discuss which policy approach is appropriate for a country during a world-wide recession.
(25)

A recession refers to when there is a fall in GDP for six months. Given the world-wide recession, this
brings about a fall in global income which lessons purchasing power and therefore there is a fall in
consumption from the fall in demand as well as a fall in investment spending due to investor’s
confidence and hence causing a drop in net export revenue. Therefore, policies are needed to curb
the world-wide recession such as using monetary and fiscal policies as well as cuts in government
expenditure to reduce budget deficits but some policies are applicable for some countries while for
others it may not be as applicable or effective. Hence, we need to consider the position of the
economy as the effectiveness and suitability of policies are subjective to each country and policies
have to be apt in order to bring about economic recovery for the country or to at least stabilize the
country.

Fiscal policy approach is appropriate for a country during a world-wide recession such as EU instead
of a monetary policy. Fiscal policy is a demand management tool that can be used to influence the
level of AD in an economy. Singapore uses the expansionary fiscal policy which refers to when there
is an increase in government expenditure(G) and a reduction of taxes(T) that can increase AD and
real national income stimulating growth in the economy. For example, a cut in personal income taxes
will cause disposable income to rise and thus there is more incentive to spend than to save and this
causes higher consumption of goods and services as well as a higher consumption expenditure. This
also brings about derived demand for labor as demand for goods and services increases causing
more job opportunities. Hence AD increases and real GDP increases as well as decreasing cyclical
unemployment. However this is applicable for countries with large reserves that the government can
tap into so as to not cause the government to go into resource crowding causing economic growth to
worsen.
Fiscal policy approach is not an appropriate approach for a country such as Singapore during a world-
wide recession. due to Singapore’s small multiplier size, given by k=1/MPW and her large marginal
propensity to withdraw (MPW= MPS+MPT) for example, CPF central provident fund. Therefore, any
increase in G, it will not cause a huge effect and is limited unless it is sufficiently large enough.
Hence, it may cause the government to strain on government budget and may drain the nation’s
reserves over time and this affects the fiscal policy where in the long run, it may become obsolete as
it becomes unsustainable and the government may even go into debt and will need to borrow from
central banks which impedes economic growth even further. Also, reliance on fiscal policy to drive
actual economic growth is also not sustainable in the long run. However, it is still an important policy
as it can complement other policies to bring about greater effect on the economy and greater actual
economic growth as well as increasing potential growth in the long run.

GPL AS

AD 1

AD 2
GDP

Figure 1. Fall in AD

Furthermore, a contractionary fiscal policy to reduce budget deficit is not an appropriate approach for
a country. The use of a contractionary fiscal policy focuses on cut downs of government spending and
higher tax rates but during a recession, there is a fall in come which leads to lower purchasing power.
Consumers consume less and cut on spending on normal goods, which leads to a contraction in
consumption expenditure. Consumers also reduce import spending causing X-M to fall. With a
pessimistic outlook at the economy as well, investors may be deterred to invest in the country due to
a low expectation of returns. This causes the AD to decrease and a fall in GPL as well as rise in
cyclical unemployment as seen in figure 1. Therefore, when a contractionary fiscal policy is in place, it
does not help the situation even if BOP improves.

On the other hand, monetary policy approach is appropriate for a country during a world-wide
recession which EU has used. Through an expansionary monetary policy, interest is lowered. With a
lower interest rate, consumption and investment rates increase causing AD to increase and real GDP
to increase via the multiplier effect. There is a rise in income which leads to greater purchasing power.
Consumers consume more and increase spending on normal goods, which leads to an increase in
consumption expenditure. Consumers also increase import spending causing X-M to rise. Banks are
also able to loan at lower interest rates to firms and firms hence have a higher rate of return and
through the multiplier process, is able to increase the AD and national income level.
However, monetary policy may not be appropriate for a country during a world-wide recession. This is
because when interest rates are set too low, over-borrowing at artificially cheap rates can occur. This
can then cause a speculative bubble, whereby prices increase too quickly and to very high levels. For
example, buying houses. When people speculate housing prices to be very low, demand increases
and prices increase. The prices continue to increase to the point that it becomes unaffordable and
hence, when the bubble bursts, demand falls and prices go very low that it can cause greater harm to
the economy. The country also runs the risk of hyperinflation if the supply of money is not controlled
as when there is too much money supply, it causes the value of the money to fall relative to goods
and services. Therefore, it may not be as appropriate for a country due to the unintended effects.

Therefore, other policies such as supply side policy is an appropriate approach for a country during a
world-wide recession. Supply Side Policies are policies are aimed at increasing Aggregate Supply
(AS), a shift from left to right due to a change in quality, quantity of the factors of production or an
increase in technology. For instance, Singapore created something called skills future to help train
workers and to upgrade their skills bringing about a decrease in structural unemployment as well as
attracting investors to invest in the Singapore therefore bringing about potential economic growth in
the long run. Furthermore, with the new water technology that Singapore uses, we are able to
produce our own NEWater via reverse osmosis technology and we can thus even help Malaysia to
process its waters and to sell it back to them, bringing about more revenue from external sources.
However supply side polices are difficult to implement and may take a long time to produce results
unlike fiscal policy which is a demand- side policy that has more immediate effects on the economy.

In conclusion, the use of fiscal and monetary policies are appropriate approaches for a country in the
face of a world-wide recession as it helps to recover the economy. However, it is not justified as no
one country only faces a single issue that only can be curbed by one policy and therefore, the country
faces numerous issues that need to be tackled with a combination of policies in order for an effective
and sustainable economic growth. Policies must also be considered carefully before the
implementation. For example, if the US is in a large budget deficit, it cannot use expansionary fiscal
policy as this the government has no means of greater expenditure and thus needs another policy to
help curb the budget deficit.