9732 Nov 2009 P2 / Qn4b

9732 Nov 2014 P2 / Qn4b

9732 Nov 2009 Paper 2 / Question 4b
Assess whether a change in the external value of its currency is more likely
to have a larger impact on Singapore or the USA.

Question Analysis:
Candidates are expected to provide an analytic explanation of how exchange
rate movements may impact both countries in terms of the macroeconomic
objectives to do with growth, inflation, unemployment and BOP position.
In assessing the extent of the impact, candidates should consider the unique
features (reference to the response to part a: smallness and openness of an
economy) of the Singapore economy in contrast with that of the USA to
arrive at a reasoned judgement.
Suggested Answer Outline
Introduction:
• Change in the external value of a currency?
• Change in the external value to do with changes in the price of SGD/USD in terms of a foreign
currency, measured in terms of the quantity of imported goods and services one unit of
currency can purchase
• Impact on a country?
• Impact to do with how the macroeconomy may be affected in areas of growth,
unemployment, inflation (internal stability) and BOP position (external stability).
• Larger or smaller?
• What economic features or characteristics?

*For consideration, what is the theoretical relationship between the external value and internal value of a country’s
currency/money?
Suggested Answer Outline
Body:
• 2-3 key areas of economic analysis include:
• Impact of a change in the external value of a currency on internal stability – growth,
unemployment, inflation
• Impact of a change in the external value of a currency on external stability – BOP
position
• Reasons for a larger or smaller impact for each area of analysis
Conclusion:
• Evaluative Comments:
• Extent of impact may differ depending on the unique economic features or
characteristics of the Singapore economy in contrast with those of the US economy.
The unique features or characteristics include openness, resource dependency,
multiplier size etc.
• For consideration: what other factors – domestic or external – may impact a country?
Suggested Answer Outline
Body 1:
• Explain the likely impact of currency depreciation and appreciation on
export revenue and import expenditure (trade performance).
• Explain the relevance of PED in explaining changes in X and M (pg6-7 of
lecture notes on EG).
• Depending on how (X-M) changes, BOT may improve or worsen  increase
in AD  export led growth  increase in real GDP (via the forward
multiplier)  lower unemployment  contribute to internal stability.
• Reason why the impact is likely to be larger for Singapore due to the
relative importance of external trade (Reference to answers to part (a): net
export to GDP ratio – net exports as a percentage of GDP).
Suggested Answer Outline
Body 2:
• Explain the likely impact of currency depreciation and appreciation on inflation – internal stability.
• Explain the links between the external value and internal value of a country’s currency (reference to notes
on Inflation and Deflation)
• Impact of currency appreciation and depreciation on unit cost of production (AS) – cost push/imported inflation (internal and
external stability).
• Impact of currency appreciation and depreciation on demand pull inflation.

• Reason why the impact is likely to be larger for Singapore. Import dependence (resource scarce), high import
content in all the components of AD and exports taking up a significant share of GDP mean that exchange
rate movements are likely to be the main cause of domestic inflation.
• Reference to imports as a % of GDP and exports as a % of GDP

*Price stability (relative inflation rates) contributes to export/economic competitiveness (trade performance).
*For consideration, can you explain the two-way theoretical relationship between the external value and
internal value of a country’s currency/money?
Suggested Answer Outline
Body 3:
• Explain differences in multiplier value between Singapore and the USA.
• More leakages for Singapore in the form of higher propensities to save and
import  smaller multiplier value  smaller magnitude of change in
induced consumption spending following a change in injection/withdrawal.
• Larger multiplier effect for the USA.
• Impact from initial injection/withdrawal larger for Singapore but impact
from induced spending larger for the USA. Considering that Singapore is
operating near its full employment level of real GDP, multiplier effect is
only partial.
 2011 GDP by Expenditure

Suggested Answer Outline

Conclusion:
• Assessment may be to weigh up the impacts or to consider the huge
disparity between the two countries in terms of their trade to GDP ratio.
• Currency movements tend to have a significant impact on countries with a
sizeable or hefty trade sector, because of the direct channels of impact that
currency appreciation or depreciation has on the key macroeconomic
indicators (performance to do with internal stability) of the economy. Given
that Singapore’s net exports (27%), imports (135%) or trade (298%) as a
percentage of GDP is far or overwhelmingly larger than that of the US, a
change in the external value of currency will more likely bring about a far
more significant impact on Singapore, despite the smaller multiplier size.
9732 Nov 2014 Paper 2 / Question 4b
Discuss the likely effects on Singapore’s national income and its components
when its exchange rate appreciates. [15]

Question Analysis:
Candidates are expected to provide an analytic explanation of how an
appreciation of the Singapore dollar may impact the components of
consumption, government spending, gross fixed capital formation
(investment) and net exports (national income by expenditure).
Areas of discussion should include both positive and negative effects by
taking into consideration unique features (reference to the response to part
a) of the Singapore economy as well as the government (MAS)’s policy of
modest and gradual exchange rate appreciation in assessing the extent to
which national income will change.
Suggested Answer Outline
Introduction
• Appreciation to do with an increase in the price of SGD in terms of a
foreign currency.
• Likely effects on national income and the components of AD  the
extent to which C, I, G and (X-M) will change and how the changes
will impact national income.
Suggested Answer Outline
Body 1
• Impact of SGD appreciation on (X-M).
• Reference to the structure of the Singapore economy – one that is trade
dependent. Note that currency appreciation does not necessarily hurt outright
Singapore’s export competitiveness due to the high import content of her
exports. A stronger currency would reduce the cost of imported inputs (price in
SGD) and hence lowers the unit cost of production  greater ability of firms to
charge lower export prices vis-à-vis prices of domestic goods and services in
other countries. Nonetheless, the overall impact may be to cause net exports to
fall depending on the overall elasticities of import and export demand (provided
the ML condition holds).
• Depending on how (X-M) changes, BOT may improve or worsen  increase or
decrease in AD  export-led growth/contraction  increase or decrease in real
GDP (via the forward/reverse multiplier)  lower/higher unemployment 
contribute to/worsen internal stability.
Suggested Answer Outline
Body 2
• Impact of SGD appreciation on investment spending.
• More likely for firms to be spending on imported capital or technology  impact
on productivity gains  export competitiveness  expansion of market share in
foreign markets.
• Influx of foreign direct investment (business confidence as well as higher returns
on investments since profits are higher when converted to the foreign currency).
• Lower cost of investment in other countries  potential fall in domestic
investment spending.
• Higher cost of investment for foreign firms. May also be concerned about the
competiveness of their products exported out of Singapore due to the stronger
SGD.
• Likely impact on both actual and potential output.
Suggested Answer Outline
Body 3
• Impact of SGD appreciation on consumption spending.
• Relatively lower prices of imports in SGD may incentivise households
to substitute domestically produced goods and services with
imported ones  change in the pattern of consumption.
• Import expenditure will change depending on the overall PED/XED
value.
Suggested Answer Outline
Body 4
• Overall positive impact (relate to the Singapore government’s policy
of maintaining a modest and gradual appreciation of SGD) due to the
openness of the economy and its dependence on imports and foreign
investments, despite the likely negative impact on net exports.
• Extent of overall increase in national income may be limited by the
size of the multiplier (partial effect since the economy is operating
near its full employment level of real output).
• Assessment of the short-term (actual growth) and long-term impact
(potential growth).