Whether SGD Appreciation Benefits the Singaporean Economy

Question

The Monetary Authority of Singapore (MAS) operates a managed float exchange rate system, whereby the trade-weighted Singapore dollar (SGD) is allowed to fluctuate within a policy band.

(b) Discuss the extent to which an appreciation of the Singapore dollar is beneficial to the Singaporean economy. [15]

Answer

When the SGD appreciates, one unit of SGD buys more foreign currency. Appreciation is the central instrument of Singapore’s exchange-rate-centred monetary policy, and its benefit must be judged against Singapore’s macroeconomic goals — price stability, growth, the external balance and employment. My thesis is that a gradual and modest appreciation is beneficial for Singapore, because as a small and open economy it is acutely exposed to imported inflation; an abrupt appreciation, by contrast, would be harmful.

Appreciation improves price stability. This is the core rationale of the exchange-rate-centred policy. Singapore imports the bulk of its raw materials and essential goods, so a stronger SGD lowers the domestic-currency price of imported inputs, reducing firms’ unit costs of production and easing cost-push inflation. Appreciation also makes exports dearer in foreign currency, lowering the quantity demanded; provided the Marshall-Lerner condition holds, net exports fall, aggregate demand falls, and demand-pull inflation eases. Both channels lower the general price level.

Appreciation can support sustained growth. Lower inflation raises the price competitiveness of exports relative to higher-inflation trading partners, supporting export revenue. A currency that appreciates at a low, stable rate also raises investor confidence, since exchange-rate stability lowers the volatility of returns; this raises the marginal efficiency of investment, attracting foreign direct investment. If that investment lifts the quantity and quality of factors of production, productive capacity rises and LRAS shifts right, so that actual and potential growth proceed in tandem — the basis for sustained, non-inflationary growth.

Against this, appreciation carries costs. A fall in net exports lowers aggregate demand, and if the appreciation is abrupt, the fall is sharp: firms facing weaker demand cut output and hire fewer factors, raising demand-deficient unemployment.

Abrupt appreciation and unemployment: a sharp fall in net exports shifts AD₀ to AD₁ in the Keynesian range, lowering real national output from Y₀ to Y₁ with the general price level roughly unchanged — a widening of spare capacity and demand-deficient unemployment.

The same fall in net exports worsens the balance of trade, and, if other components are unchanged, can push the balance of payments into deficit.

Judgement. Whether appreciation is beneficial turns on its magnitude and rate and on the state of the economy. Because Singapore imports almost all of its goods, services and raw materials, it is extremely susceptible to import-push inflation: even a small depreciation can raise the general price level sharply, so the price-stability gain from appreciation is correspondingly large. The unemployment and growth costs arise chiefly when appreciation is abrupt or ill-timed. Kept gradual and modest, and deployed when inflationary pressure is high, appreciation is on balance beneficial. The economy benefits most, however, when appreciation is paired with other instruments — for instance, expansionary fiscal policy during a downturn to support aggregate demand, since under the policy trilemma Singapore manages the exchange rate rather than the interest rate and so cannot also run an independent expansionary monetary policy.