Is monetary policy enough to fight inflation?

By Aaron Low, The Straits Times, 14 Apr 2012

IN 2008, Singapore's inflation rate climbed to a 30-year high of 6.6 per cent.

To contain rising prices then, the Monetary Authority of Singapore (MAS) tightened monetary policy and allowed the Singdollar to appreciate. To be precise, it allowed an unusual one-off jump in the Singapore dollar's value.

This made the price of imports in Singapore instantly cheaper. Since 2008's inflation was fuelled by sky-high food and energy prices, it worked remarkably well to bring down inflation.

Yesterday, in response to a higher inflation forecast for the year, MAS again tightened monetary policy, allowing the Singdollar to appreciate at a faster rate.

Will monetary policy be as effective in 2012 as it was in 2008?

The answer is probably no. That's because the nature of inflation today is somewhat different from what it was four years ago.

Yes, imported cost pressures are still high, owing chiefly to the high oil prices amid tensions in the oil-rich Arab world. So a strong Singapore dollar will help cushion the impact of rising oil prices and other imports on Singaporeans.

But this time, higher prices are also being driven by domestic cost pressures that have little to do with imports or the value of the Singdollar overseas.

Yesterday, MAS flagged the tight labour market as one potential reason why 'core inflation' (that is, minus the cost of accommodation and cars) is going up this year. This is because higher labour costs - partly the result of the Government tightening the tap on cheap foreign workers - are clearly passing through to many sectors of the economy.

Health care, education and recreation have all seen faster price increases in recent months, largely due to the fact that these services are still relatively labour-intensive.

Tightening monetary policy will have much less of an effect on this source of inflation.

What is worrying is that these domestic price pressures will probably remain for some time to come, reckons DBS economist Irvin Seah.

'Cutting labour supply and raising foreign worker levies, as part of economic restructuring, will add to cost pressures as firms will not be able to raise productivity in the short run,' he says.

Another source of inflation is land. Going by anecdotal evidence, businesses are facing rising rentals. This is another domestic driver that the exchange rate policy has little effect on.

To be sure, the stronger exchange rate can still work through indirect means to combat domestic inflation.

Citigroup economist Kit Wei Zheng notes, for example, that a higher exchange rate will work to dampen external demand for Singapore's goods and services, which may help ease domestic demand for labour and land.

'For instance, in the tourism sector, with a stronger Singdollar, we become less attractive to tourists, who may then prefer to go to, say, Malaysia,' he explains.

But these secondary effects take much longer to come through the system, and some say it is questionable if they will happen at all.

At the same time, there are other secondary effects to contend with, working in the opposite direction.

A stronger Singdollar also attracts foreign inflows of capital, for example. This increases the money supply and raises asset prices.

What all this means is that, looking at where we are in 2012, monetary policy alone cannot be the only weapon in the tool kit to combat inflation. Other strategies to bring down prices will have to be applied in tandem.

The Government has already moved to cool foreign capital inflows in the property market through the introduction of the additional buyer's stamp duty, which targets foreigners directly.

A greater supply of land for residential and industrial property will also help to dampen prices and rentals in the next few years, says Bank of America Merrill Lynch economist Chua Hak Bin.

The Government may need to look more closely at business rentals next, and even the fees and charges it levies on businesses and consumers.

Unlike in the past, inflation will not go away with a quick fix. Policymakers will have to fire on more cylinders if they are to effectively deal with the problem of fast-rising prices in the months and years ahead.

Singapore avoids recession but inflation a big worry
by Wong Siew Ying and Yvonne Chan, TODAY, 14 Apr 2012

The economy rebounded strongly in the first quarter to avoid a recession, but with rising prices hurting consumers and businesses, the Monetary Authority of Singapore (MAS) yesterday allowed for a stronger Singapore dollar as it raised its inflation forecast.

"The MAS move is a slight surprise, but it was made possible by the healthier-than-expected gross domestic product numbers," said DBS Bank economist Irvin Seah.

Initial estimates from the Ministry of Trade and Industry yesterday showed Singapore's GDP grew by 9.9 per cent the first quarter from the previous three months, reversing the 2.5-per-cent decline in the fourth quarter and beating the median analysts' forecast of a 6.3-per-cent rise.

From the corresponding period last year, first-quarter GDP rose 1.6 per cent, down from the 3.6-per-cent rise previously but topping a 0.7-per-cent analysts' forecast.

STOCKS RISE IN ACTIVE TRADE

Singapore shares ended higher in very active trading after the growth data, helped by gains in regional peers. The Straits Times Index rose 9.68 points, or 0.3 per cent, to close at 2,987.82, having advanced as much as 0.9 per cent earlier in the day.

Stronger performance in the manufacturing sector played a key role in the first-quarter rebound in what some economists called a "re-acceleration" of Singapore's economy. The sector grew by 14.7 per cent from the previous quarter, driven by higher output in the electronics and precision engineering sectors.

However, the sector contracted by 2 per cent from the previous corresponding period as a result of the high base effect.

Mr Seah said: "All leading external indicators for the electronics industry are pointing to a stronger growth momentum going forward in this segment. Purchasing Managers Index numbers for all key markets are now above the crucial 50 level, implying that the manufacturing sectors for some of our key markets are in strong expansion mode."

The construction sector also grew an impressive 24.6 per cent quarter-on-quarter and 6.2 per cent year-on-year. Analysts said this was largely due to a pick-up in residential construction activities and public transportation projects.

Meanwhile, the growth in visitor arrivals continued to boost the services sector, which grew 6.9 per cent quarter-on-quarter and 2.9 per cent year-on-year.

Looking ahead to the second quarter, economists said the stable growth in the services sector - led by the financial services and tourism industries - should help to offset any moderation in the manufacturing and pharmaceutical sectors.

INFLATION BECOMES A BIGGER WORRY

Amid the economic recovery, inflation continued to rear its ugly head.

Four days after Trade Minister Lim Hng Kiang said in Parliament that the MAS was "very concerned" about stubbornly high inflation, the central bank forecast the consumer price index to rise between 3.5 and 4.5 per cent this year, up a full percentage point from its earlier forecast. The MAS said its core inflation measure, which strips out private road transport and accommodation costs, would average between 2.5 and 3 per cent, also a percentage point higher.

Catching the market by surprise, the MAS tightened policy, saying it would increase the slope of its policy band slightly for a modest and gradual appreciation of the Singapore dollar. It restored a narrower trading band and said there would be no change to the level at which the band is centered. Most economists had forecast no change in monetary policy.

The Singapore dollar rose after the announcement to end the day 0.6 per cent higher at S$1.2450 to the US dollar.

With economic activity turning out somewhat stronger than anticipated in the first quarter and with "resource markets" tightening further, the MAS said core inflationary pressures had persisted.

Core inflation rose to 3.2 per cent in the first two months of 2012 from 2.4 per cent in the fourth quarter of last year, even as headline inflation moderated to 4.7 per cent from 5.5 per cent.

The MAS said inflation rates would remain elevated over the next few months, before easing over the remainder of this year.

The MAS, which uses the exchange rate as a tool to control inflation, said the new policy stance would help anchor inflation expectations, ensure medium term price stability and help keep growth on a sustainable path.

However, some analysts are concerned that a stronger Singapore dollar may affect the competitiveness of Singapore's open economy.

Mr Robert Prior-Wandesforde, Credit Suisse's director for Non-Japan Asia Economics, said: "In real terms, the Singapore dollar is rising more rapidly, so that means competitiveness is being lost at a fairly significant pace right now. The labour market is very tight, wages are at high levels and likely to rise further."