Inflation is defined as the sustained increase in the general price level of goods and services in an economy. Inflation in Singapore can be caused both by domestic and external demand-pull and cost-push factors.
Singapore mainly suffers from demand-pull inflation, which may occur when increases in aggregate demand (AD) persistently exceeds that of aggregate supply (AS), causing excess demand when the economy is near or at full employment. Inflation, in this case, is due to the rise in AD, which can come from the rise in C, I, G and (X-M), therefore causing the upward pressure on the general price level (GPL).
In the case of Singapore, the major source of demand-pull inflation would be the rise in income of her trading partners, which lead to the increase in the purchasing power of households. This, in turn, causes greater an increase in the demand for Singapore’s exports. When there is a rise in Singapore net exports, her AD rises, leading to the rise in the general price level, assuming the economy is already at near or full employment. This was evident when countries like the US recovered from the 2008 global financial crisis. As the US is one of Singapore’s largest export market, and when the latter’s national income rises, the demand for Singapore’s export rose. Since the value of Singapore’s exports is more than twice the size of her domestic economy, this will have a significant impact on the AD and hence GPL.
In addition, there might also be an increase in Foreign Direct Investment (FDI) given a higher expected rate of return of investing in Singapore when external demand rises, given that multinational corporations (MNCs) which produce in Singapore tends to be export-oriented. An increase in FDI will lead to a rise in AD, and should the economy have limited sparse capacity, a persistent increase in AD will likely lead to upward pressure on prices on the GPL.
Singapore can also face demand-pull inflation from domestic sources. For example, with the recovery of the Singapore economy after the financial crisis, the purchasing power of household rose. Together with the influx of foreign workers coming into Singapore, this also increased the domestic C and AD, and hence GPL.
Cost-push inflation occurs when prices are forced upwards by the increase in the cost of production not caused by excess in AD. If firms face a rise in unit costs, they will respond partly by raising prices, partly by passing the costs on to the consumer, and partly by cutting back on production. The causes of cost-push inflation are from the supply-side. The rise in costs may originate from wage-push, imported inflation and depreciating exchange rates.
A source of cost-push inflation in Singapore would be the increase in global demand for raw materials or commodities such as food and oil. This increases the unit cost of production as these raw materials are the important factor of production, causing the AS to rise upwards and therefore raising the GPL in Singapore, leading to cost-push inflation. For example in 2012, the average crude oil price was at historically high levels because the OPEC restricted their oil production. This was an important contributing factor to Singapore’s high inflation rate that year since demand for her imports are price inelastic, and with little or no substitutes to the imported raw materials like oil, the GPL in Singapore rises.
Another cause of Singapore’s cost-push inflation would be the government’s efforts to reduce the inflow of foreign workers. Tightening of foreign labour policies has led to the overall labour force rising slower than the demand for labour, thus resulting in a labour shortage. With the rise in wage rate and productivity growth lagging behind, unit cost rises. Hence AS shifts upwards and lead to cost-pull inflation.