Macroeconomic Policy to Combat Inflation – Speech by Jamus Lim

Mr Speaker, I wish to speak today on how macroeconomic policy can and should play a role in addressing our cost of living challenges.

The state of inflation is not good

As members on both sides of this House are aware, the state of inflation in Singapore is not good.

Since the start of the year, inflation in the prices faced by consumers has averaged 4.9 percent. This is more than double the rate, of 2.3 percent, for 2021. And it is also close to double the average since our nation’s independence.

The pain of this rising cost of living is even more keenly felt by the average household and small business.

Food inflation is up to 4.5 percent, more than three times higher than last year. While news headlines (and my mother’s constant reminders) focus on costly chicken—and the threat to what most consider our national dish, chicken rice—prices of all kinds of meat are up to almost 6 percent, eggs are about 30 percent pricier, and even those choosing a healthier diet face vegetables that are 5 percent more expensive.

Another area where prices have shot up is in energy. I am certain I am not the only member here who has received irate emails from residents who have expressed shock and dismay at their utilities’ bills. Small wonder: electricity is 20 percent dearer than a year ago, and gas more than 10 percent. This not only means that more of us have been sleeping without the aircon on. It also means that our small businesses, already operating on lower sales because of the pandemic, face even thinner margins.

With fuel prices up by a quarter, it is unsurprising that transportation is now more expensive, with price rises in the teens, compared to a year ago. And this isn’t just affecting those who have the luxury of owning cars or getting on planes for the holidays. Public transportation costs are up more than 7 percent. For families that rely on the occasional taxi or PHC to get their kids to school when they are running late, this option has become much more difficult.

When the prices of what we eat, getting to work, and keeping our homes and businesses running are all rising rapidly, this isn’t an inflation problem any longer. It is a cost-of-living crisis. It is therefore incumbent on policymakers to do what they can to alleviate the pain felt by the people.

Why we can and should act now

To be clear, the drivers of inflation are multifaceted. A significant part of inflation is global in nature. For example, the prices of commodities — such as food and energy — have climbed higher since the middle of last year. The war in Ukraine fed further uncertainty, and led to spikes in the prices of wheat, corn, and sunflower oil. And supply chain pressures—not just in China, where the administration’s stubborn adherence to a zero-COVID policy has led to rolling lockdowns—but also globally have meant more upward pressure on prices. Tight labor markets worldwide have seen wages add their own powerful contribution to the inflation mix.

At first glance, such imported inflation looks to be something beyond our control, since we are a small open economy that is a price-taker on global markets. However, it is incorrect to insist that inflation must be a storm that we simply need allow time to pass. The experience of advanced economies that are around a half-year ahead of us in confronting the price dragon suggest that inflation may—like the last drunk, uninvited guest at a party—hang around longer than we’d like or appreciate. Their central banks
have already abandoned rhetoric that the phenomenon is “transitory.” None other than our own MAS has pointed out that only about a third of the increase in core inflation is due to external sources, with about half due to domestic drivers. With the source of inflation emanating domestically, it behooves us to act locally.

There are genuine consequences of failing to act. In addition to the real costs borne by various segments of the population, refraining from decisive action now could allow inflation to become even more entrenched in the expectations of our households and businesses. This runs the risk that inflation becomes more permanent than temporary.

The role of macroeconomic policy is to stabilize the economy. While the government has announced a suite of measures in an off-budget fiscal package, I believe more can be done at this juncture, from a big-picture perspective.

Using other available tools to tighten monetary policy

In most economies, the first line of defense against inflation is the central bank. But as explained yesterday by DPM Wong, our nation’s central bank, the Monetary Authority of Singapore (MAS), does not operate as a traditional central bank, relying on short-term interest rates to manage price pressures. Instead, it subordinates the policy rate to exchange rate considerations, consistent with our open economy and considerable
exposure to international trade and financial flows.

Regardless of whether one agrees with this approach — I, for one, do — it is also well-understood that, having adopted such a target, we can no longer control inflation via traditional interest rate hikes. But thankfully, this does not mean that there are no other tools in the monetary authority’s toolkit.

One strategy, developed in recent decades, is to intervene in markets for financial assets. Some of us may be familiar with the process of quantitative easing (QE): the central bank makes large-scale asset purchases, to keep long-term interest rates low. The objective of QE is to stimulate the economy in the face of interest rates close to zero. Over the past decade, QE was applied by the major developed-economy central banks, such as the Bank of Japan, the Bank of England, the European Central Bank, and the U.S. Federal Reserve, with some success.

Quantitative tightening (QT) is essentially the opposite: the central bank will intervene in markets to sell longer-term government bonds. 9 This will bid down their prices and, conversely, raise their yield. Thus, even though the MAS would not seek to directly increase the Singapore cash rate—currently at 0.7 percent—it could nevertheless influence interest rates of government bonds maturing in 10 years or later.

Whether via QT or other means, it strikes me as eminently reasonable that the MAS attempts to elevate such long rates, so that the real interest rate—that is, the interest rate, net of inflation—would no longer be negative, as it currently is. This would represent a genuine tightening of monetary conditions, which is what is necessary to contain inflation.

Exchange rate policy for inflation control

Of course, the most direct approach to controlling inflation in the context of our current policy framework is to have the MAS target a stronger Singapore dollar.

Sir, I appreciate that the legislature is seldom the place for in-depth discussion about as esoteric a topic as the appropriate level of the exchange rate. I am also keenly sensitive to how the monetary authority operates best when left relatively free rein over how they conduct the more technical elements of monetary and exchange rate policy.

That said — as I shared with this House early this year — while the execution of policy is indeed best left to experts, the choice of what policy to pursue falls appropriately within the domain of politicians, who are best positioned to debate the relative merits of tradeoffs that affect the welfare of the people we represent. It is with this in mind that I am broaching the issue of our exchange rate.

I believe that we can do more to strengthen the Singapore dollar. This will reduce the costs of imported goods and services, and since so much of what we consume is imported, a strong SGD can in turn can lower domestic inflation as well. As Minister of State Alvin Tan shared with this House two months ago—and again yesterday—MAS is aware of this, and had already tightened monetary policy thrice since October last year. But it is unclear how much this effort to strengthen the Singapore dollar has succeeded.

This could be because, of the three moves, only the most recent one was sufficiently aggressive, involving an adjustment of not just the slope but also the midpoint of the policy band, while the other two were far more limited. 16 But the proof is in the pudding. On October 14 — the day of the first MAS announcement — the exchange rate between the U.S. and Singapore dollar was 1.35. As of mid-June, after 3 separate efforts, this was $1.40; getting close to 4 percent weaker than when the exercise first

Now, there are many reasons why this may be the case, not least because the U.S. dollar has been exceptionally strong, even compared to other currencies. But the reality is that the Sing dollar is, today, weaker in terms of the currency that global commodities like oil, gas, and agricultural products are priced in, which is the USD. This translates into higher prices here, as higher input prices pass through into domestic inflation. The efforts of the MAS are, demonstrably, too tentative. And what’s worse, we risk falling behind the curve even further, as the Federal Reserve recently moved to hike rates more aggressively, which will fuel further appreciation of the U.S. dollar.

Sure, such a policy will entail winners and losers. We may be concerned about what the effects of a strong exchange rate could mean for our exports. But there are reasons to believe that currency appreciation needn’t be that problematic for exports. We should not forget our entrepôt model and natural resource scarcity means that our producers often import raw materials and other intermediate inputs to production, and will benefit from a stronger SGD. Our economy is also less reliant on manufacturing than before, and a number of our tradable services—in finance, ICT,
and professional services—have pricing power, which allows them to be more resilient to exchange rate fluctuations. By a similar token, capital inflows may also remain unaffected by currency appreciation, and could even potentially increase. After all, multinationals based here can manage foreign exchange risk through hedging, as long as plans are telegraphed in advance. And in the long run, a stronger currency may provide the impetus for our local firms to upgrade their operations to reflect higher productivity and quality, rather than solely competing on low prices and cutting costs.

There are, of course, reasons for caution on this front. Even casual students of international economic history will have encountered the Plaza Accord, an agreement struck between the then-leading nations 23 to intervene in currency markets to strengthen the Japanese yen and German deutschmark, relative to the U.S. dollar. The result was a success, but some observers have argued that the concerted intervention set in motion the Japanese real estate and stock market bubble, and the economy’s
subsequent lost decades.

Even so, there is ample evidence that we can afford more strengthening of the Sing dollar. Standard metrics for comparing the under or overvaluation of our currency suggest that the Sing dollar is significantly undervalued. There is latent demand for the SGD, as an attractive, safe-haven currency in these tumultuous times.

Hence, paradoxically, we may not need to spend very much at all to prop up our currency. It may be as simple as ceasing interventions restrain our exchange rate, and allowing foreign exchange markets to work. This is a luxury that precious few countries can afford, but is one that we can leverage on now.

Principles to guide fiscal policymaking

These monetary and exchange rate moves should occur alongside fiscal policy. I will suggest three general principles that guide our thinking on this matter.

First, should subscribe to the general principle of being timely, targeted, and temporary. I have already outlined why support is needed now. It is also timely given how a souring of global economic environment means that we must rely less on global growth tailwinds to support our economy. Targeting specific groups and keeping the policy temporary will also minimize the budgetary footprint, at a time when we have already drawn liberally from reserves, and the economy is on track toward a self-
sustaining recovery.

Second, our fiscal balances should not be building up excess surpluses at this time. This means that increased revenues resulting from higher collections of various taxes and duties should, as far as possible, be rebated back to citizens. This ensures that the government does not enjoy a windfall gain while our citizens suffer.

Finally, it is important that we avoid the temptation to index economywide wages to inflation. While tempting—since it automates the process of wage adjustment to rising inflation—the experience of emerging economies in the 1980s and 1990s are a testament that this well-meaning policy can end up institutionalizing inflation.

While the package announced last month by the Ministry of Finance is based on three somewhat different philosophies, it also embeds some of the principles I mentioned: of being temporary and targeted, and relying on the “better-than-expected fiscal outturn” from the prior fiscal year.

But we can probably do more. Revenue for the previous fiscal year (FY2021) was $74.8 billion, $13.4 billion higher than FY2020, and $7.1 billion more than two years ago. The jump in property stamp duty alone was $6.8 billion, even as personal and corporate income taxes have fully recovered. Yet the announced package only amounted to $1.5 billion, a fraction of this revenue increase.

Returning returns to those on fixed incomes

One important example of policy that follows these principles is to make adjustments for Singaporeans on fixed incomes. For such people, inflation can be devastating. An elderly person spending $20 a day may now be only able to buy one prata instead of two for breakfast, be forced to skip their afternoon tea, or order two instead of three items of caipng. And what’s worse, this diminished consumption will be with them for the rest of their lives, even when inflation has returned to normal rates, because elevated prices do not automatically come back down even after inflation disappears. Inflation 3 percent above the historical average will mean that their retirement funds now buy 3 percent less.

In practical terms, this means adjustments to those that rely on Comcare and CPF. We have to remind ourselves that—while financial markets can and do adjust returns to reflect higher inflation—this is not the case for those locked into a fixed income stream.

For retirees, CPF returns have remained unchanged thus far, even as higher prices mean that whatever these retirees have set aside in saving will now buy less. For Comcare, the announced increase for Long-Term Assistance is surely welcome, but it is unclear why a comparable degree of support is not extended for short- and medium-term assistance, since inflation hits both types of households in much the same way. I believe that Comcare assistance should be permanently and universally increased, by a margin that reflects the excess inflation experienced by families for this year.

I also believe that we can roll out a temporary increase in CPF interest rates—of around 2 percentage points for a 6-month period—consistent with the increase in inflation. This can be funded by increasing the returns paid on Special Singapore Government Securities (SSGS). The higher returns on SSGS can, in turn, be made up from higher nominal returns that would accrue from financial assets that are marked to market.

Why this suite of macroeconomic policies make sense

Macroeconomic policies are often viewed as blunt instruments: they affect the economy on the aggregate, and hence, we may be concerned that pushing these levers may be too disruptive for an economy that is already on a tentative road to recovery. On the contrary, my contention is that it is precisely because the effects of macro policy are wide-ranging that we wish to consider applying such tools at this time.

For starters, a number of the policies that I discuss—associated with interest and exchange rates—have the benefit of being fast to implement. Budgetary measures take time to draw up and disburse. In contrast, interest and exchange rate policies can be rolled out in days, once a decision has been made.

Moreover, the suggestions I have made are complementary in nature. The monetary measures deployed to cool inflation are contractionary, as they should be, by design. To limit the risk of derailing a still-fragile economy, we should offset this effect with fiscal measures that are modestly expansionary. The government’s support package is consistent with this, but this risks being unwound by the impending GST hike.

Instead, what we want is a macro policy stance that is broadly neutral, which is what is appropriate for our economy at this stage of the business cycle. Put another way, we want to downshift and tap on the brakes to contain inflation, but pumping in a wee bit of gas with limited government spending that helps keep the engine from stalling.

Concluding thoughts

Mr Speaker, I appreciate that most of this speech has been relatively technical. To some extent, this is inevitable; the nature of macroeconomic policymaking is often technical in nature. Nevertheless, it is possible to summarize my main suggestions in a few sentences.

Strengthen the Singapore dollar, because a strong currency makes the stuff we import cheaper. Buy long bonds, because this will dampen speculative investment and keep a lid on asset prices. Spend to support those among us that are hurting most, for a temporary period, and finance this by rebating any windfall tax gains. But avoid wage indexation at all costs.