Economic Policy and the Global Environment-Samples for Students

Question: Discuss about the Incidence of rise in interest rate in US Economy on the Singapore Economy. Answer: Introduction The report focuses on the incidence of rise in interest rate in US economy on the Singapore economy. US economy has kept the interest rate at the zero level over the years to keep unemployment rate at low level. However, zero interest rate discourages savings in the economy the savers get less return for an ultralow level of interest rate. Therefore, people may be interested to invest in stock market rather than banks. With zero interest rate, there is infinitely large demand for loanable fund, whereas supply of loanable funds would be at the declining stage (Jennings 2016). As a result, price of natural resources and environment damage may increase. Therefore, with persistently low interest rate may results in low economic growth that has been experienced by US. US economy maintains zero interest policy through quantitative easing that is by printing new money. Swelling in money supply in the economy raises inflation rate. Hence, the main reason to increase the interest rate in US i s to bring stability. Persistent low interest rate is not effective for world economy. Many developed and emerging economies have set ultra low interest rate to revive economic growth. Economies in the Euro zone such as Denmark, Sweden, Japan and Switzerland have negative interest rate after global economic crisis. Interest rate hike is an indication that the US Federal bank is confident about the potential of the economy and its capability to manage higher borrowing costs. Drop in business may create negative impact on the employment, per capital income and standard of living of Singapore economy. Interest rate hike may create impact on global economy as the investment in the US economy becomes lucrative. As savers are benefitted, capital inflows increases in the economy. Demand for dollar from external economy is likely to rise and dollar may appreciate. As mentioned by Daly (2015), many emerging nations borrow in dollar. Therefore, appreciation of dollar increases the cost of payment against dollar. As a result, debt burden of the emerging countries increase. As dollar becomes expensive, expenditure of Singapore, travellers have to spend more. Moreover, hike in US interest rate will increase the price for mortgage, business loans for Singapore borrowers. The effects are discussed in this report in details. Effect of rise in US interest rate on Singapore economy Federal Reserve of US has raised the short-term interest rate in 2016 after almost 10 years later. As mentioned by Kapur (2015), the rate hike would have three effects on the Singapore economy in the form of property prices, export growth and capital flows. Singapore banks lend each other by through Singapore Interbank Offer rate and Swap Offer rate denominated in US dollar. Whereas, rte for residential mortgages are linked to the SIBOR, commercial property loans are linked with the SOR. Hence, when US interest rate rises, both SIBOR and SOR are likely to increase to affect the property values in Singapore economy (Feng 2016). Moreover, as cost of borrowing rises, demand for residential housing is likely to dwindle. Investment in the housing market may decline due to the higher cost. Domestic economy of Singapore may contract due to lack of demand. Hike in interest rate is a signal of growth of the US economy. Therefore, demand for export from US economy is likely to increase. However, as hike in US interest rate is not much as it was expected. Sluggish US economy may negatively affect the Singapore economy. Singapore exports machinery, electronics and refined petroleum products to the US. US dollar appreciated with the appreciation of the US dollar and therefore, import in this country becomes cheaper compared to export. In the view of Jennings (2016), as Singapore is a major trading partner of the US economy, interest rate hike may increase Singapore export. As interest rate in US is likely to rise, there is a chance of capital outflow from the Singapore economy. Investment in the US market may rise and that in Singapore may decrease due to increase in borrowing cost. Reaction of central bank of Singapore on US interest rate As hike in interest rate is likely to increase in mortgage rate, the homeowners can expect a greater monthly instalment on the housing loan. Singapore interest rate sets by the Central Bank of Singapore are positively correlated with the US interest rate. Hence, the rates on credit card, mortgages, and vehicle loan and banks savings are likely to rise. If Central Bank of Singapore hikes interest rate, savings in the economy is likely to increase. SIBOR is likely to rise. The Monetary Authority of Singapore uses currency exchange rate instead of interest rate control to set the monetary policy (Kapur 2016). The Monetary Authority of Singapore has kept the rate of appreciation of the nominal effective exchange rate of Singapore currency at zero percent. This policy has been taken for medium term price stability in the economy. Main policy consideration of MAS is restraining inflationary pressure. In order to reduce effect of US policy change, MAS has decided to keep exchange rate float ing within an unspecified policy band. Figure 1: Equilibrium under floating exchange rate (Source: Chandran 2017) Figure 1 depicts the equilibrium under floating exchange rate. PY/PM is the relative price of export. Equilibrium exchange rate is e1, where export and import are equal by the amount of 0A1. A1Z1 is the spending on the domestic product. Figure 2: Effect of expansion in export (Source: Chandran 2017) A rise in US interest rate makes appreciation of US dollar and depreciation of Singapore currency. Currency depreciation makes Singapore export cheaper to US economy. As a result, export increases from point A1 to A2. Exchange rate rises to e2. Depreciation makes import costlier and hence, demands for domestic consumption falls to A2Z1. International transaction may not increase the national income of the Singapore economy. Floating exchange rate adjusts equilibrium exchange rate automatically through market forces. Under floating exchange rate, increase in export is greater than that under fixed exchange regime. Figure 3: Equilibrium when export is increasing (Source: Chandran 2017) Under floating exchange rate, export increases and the export curve shifts to X2. As a result, exchange rate increases to e2. As described by Boon (2017), amount of international trade under floating exchange rate is A2, where impact on exchange rate is due to shift in export curve. A2 is less than traded amount A3, under fixed exchange rate. Hence, it can be said that under floating exchange rate monetary policy is contractionary. Although trade volume in short run between US and Singapore is likely to increase, overall effect on trade volume is shrinking. MAS have kept home loans competitive to allow competition in the money market among banks. As cited by Chong Tee (2013), chances of rise in deposit rate are low as compared to loan. Deposit rates are more dependent on liquidity of the commercial banks. Reaction of Singapore government Singapore is one of the fastest growing Asian economies, which is characterised by speedy GDP growth, improvement in home distribution, and improving standard of living. Balancing budget and keeping low tax burden are basic principles of the fiscal policy of Singapore. This policy focuses on the medium and long term objectives. As described by Low (2017), Singapore economy is an open economy and relies on import heavily. Singapore government emphasises on increase in aggregate demand. In order to boost up aggregate demand, the government direct cost cutting measures rather than expansionary fiscal policy through tax cut or increasing spending prescribed by Keynes. Cost cutting measures are adopted through reducing contribution rate of employers to central provident fund. Singapore government runs fully funded social security system. US interest rate hike may decrease the growth rate of the Singapore economy. In order to enhance medium term growth of the economy, the government now emphasises on the cyclical considerations. Government has taken four fiscal policies to bring stability in the economy such as maintaining fiscal discipline, achieving persisting growth, redistribution and reduction in distortion and managing reserve (Woo et al. 2013). Singapore government to boost up aggregate demand at the time of recession provides funds subsidy, transfer payment to the household during crisis and other relief measures. Singapore government highly depends on the market-based mechanism. Therefore, government avoids unnecessary intervention into the market. As cost cut measure is used in the economy, firms need to supply product at a lower cost. This loss-making firm gets incentive or subsidy to make up losses. The objective of the cost cutting policy is to put limit on overconsumption. Therefore, government takes bal ancing fiscal strategy to bring stability in the domestic economy (Bachmann and Bai 2013). Market mechanism reduces market failure in the economy to have both production and allocation efficiency. Government tries to keep budget deficit at low level so that Singapore does not have to rely on external debt for spending. Impact of hike in interest rate in US and the impact on capital flows are less on Singapore economy. Each department of Singapore government receives a block budget for five years and hence their spending become limited. Each ministry can freely choose what to produce, how to produce and how to allocate resources within limited budget. One benefit of restricted budget is that it helps to reduce unproductive spending. However, as argued by Frankel et al. (2013), limit spending for five years may create problem as government may face any unprecedented circumstances in the economy or external monetary shock, where more funds may be required. Overtimes, some departments may need to spend higher for the sake of the economy. However, with restricted budget change in pre decided plan or to manage future challenges becomes difficult. Another important feature of the Singapore government is to accumulation and management of reserves. Reserve of this country serves as contingency funds and the returns from the investment are share between present and future generations. Government is bound to spend only 50% of the net investment income to ensure growth in the national reserve and the entire money is not spent on only current needs (Tang, Liu and Cheung 2013). Hence, Singapore government can use this excess reserve funds to tackle any external economic shock effectively. Recommendation As Singapore government follows five year planning and budget, budget can be prepared bi yearly so that regular needs can be checked. Expansionary fiscal policy can be recommended, as this is effective to deal with the problem of external shock, recession. Hike in US interest rate can attract capital from Singapore economy. In order to restrict capital outflow, monetary authority of Singapore can focus on the interest rate control along with currency policy. Conclusion The report has highlighted the impact of hike in US interest rate on Singapore economy and its policy responses. It has been studied that both fiscal and monetary policy are stable in the economy and government relies on medium and long term policies rather than short term policies. Hence, government remains prepared to manage any external shock. The main reason of US hike in interest rate is to enhance their growth rate by reducing inflationary pressure, creating unemployment. Dollar appreciates with increase in interest rate. Therefore, demand for import in the US economy rises. As Singapore is a major trading partner of US, demand for export in Singapore is likely to increase. However, impact of capital flow is uncertain. Singapore government controls fiscal policy and Monetary Authority of Singapore manages the monetary policy. Monetary policy is controlled in Singapore through currency policy rather than change in interest rate. Government has changed the fixed exchange rate to floating rate to make export, import flexible. Restrictive budget, contingency reserve funds and cost cutting measures are the main characteristics of the Singapore government fiscal policy. Government focuses to boost up aggregate spending by providing subsidy rather than reduction in tax. Fiscal policy in the economy is seemed to be stronger compared to monetary policy References Bachmann, R. and Bai, J.H., 2013. Politico-economic inequality and the comovement of government purchases.Review of Economic Dynamics,16(4), pp.565-580. Boon. R., 2017. Fed rate hike: Expect to pay more monthly on home loans. Available at: https://www.straitstimes.com/business/companies-markets/fed-rate-hike-expect-to-pay-more-monthly-on-home-loans. [accessed on 06.12. 2017] Chan, P, S., 2016. US Federal Reserve raises interest rates: what happens next? Available at: https://www.telegraph.co.uk/business/2016/12/14/us-federal-reserve-set-raise-interest-rates-happens-next/ [accessed on 06.12. 2017] Chandran, N., 2017. 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