Singapore’s core inflation rate, inflation that excludes items with historically high price volatility, was at a 10-year high of 2.9 per cent year-on-year in March. In the same month, the Consumer Price Index, a broader measure of the cost of living, rose to 5.4 per cent year-on-year. Private transport, food, and services accounted for most of this increase.
Inflation has similarly visited other countries. Major economies including the United States and Europe are reporting historically high inflation rates in recent quarters. Besides the pandemic, policymakers worldwide now have one more obstacle to fight before their economy can recover.
Some external factors led to higher prices in Singapore. The Monetary Authority of Singapore (MAS) and the Ministry of Trade and Industry said in a joint statement that “external inflationary pressures have intensified amid sharp increases in global commodity prices and renewed supply chain disruptions driven by both the Russia‐Ukraine conflict and the regional pandemic situation.”
Whether these inflationary pressures would recede soon depends on how persistent these external shocks are. Russia and Ukraine are the major exporters of oil and wheat respectively. The current conflict between the two countries and associated economic sanctions mean that energy and agricultural sectors across the world would be severely affected.
Commodity prices soar and many items become scarce. This adds inflationary pressure on food and energy globally. The displacement of people and the destruction of infrastructure in Ukraine may impose capacity constraints for years, such that it is hard to fulfil global food demand.
On the other side of the world, lockdowns in China amplified the global prices of goods and services. In April, China’s manufacturing activity fell to its lowest level in more than two years. This blow to the manufacturing powerhouse creates further stress for global supply chains. That means increased costs for delivery, higher prices and greater inflation.
When inflation comes knocking, a less obvious but pernicious companion is the excessively lax monetary and fiscal policies. Major central banks and governments enacted these policies during the pandemic to avoid a severe economic downturn. But the results have come back to haunt them.
For example, the US government had issued an additional US$3 trillion debt to fight the pandemic. This amount was mostly absorbed by the balance sheets of different Federal Reserve Banks and it also put further pressure on the sustainability of the fiscal position of the US government.
Before the pandemic, the US government debt was about as much as the country’s annual Gross Domestic Product. Today, it is around 140 per cent of annual output.
These lax policies fueled the costs of living in major economies, threatening the stability of prices. The annual inflation rate in the US was 8.5 per cent in March 2022, the highest since December 1981. How much of this inflation is caused by these lax policies, as opposed to the disruption of the supply chain and geopolitical tension, remains an essential question for policymakers.
High inflation in major economies like the US may cause inflation in other countries to rise, depending on the various exchange rate regimes.
Inflation in this context would mean investors may perceive that the US government may not be able to generate enough fiscal surpluses to serve these debts or that the US Federal Reserve would have to assume these interest-bearing obligations, causing the value of the US dollar to erode.
To control inflation risk and anchor the expectation of low-risk inflation, meaningful structural fiscal reforms are needed in countries like the US. But fixing structural fiscal issues are always difficult and it often faces hurdles from many fronts. Urging for austerity, politically speaking, is often a difficult message.
On the monetary side, the FED has already made the first step. Contractions in monetary supply and hikes in interest rates are already in place. The Fed, in a statement on 5 May, reaffirmed its commitment to achieving an inflation rate of 2 per cent over the long run and “decided to raise the target range for the federal funds rate to 3/4 to 1 per cent and anticipates that ongoing increases in the target range will be appropriate”.
In the light of higher global inflation risks, the MAS, in its latest Monetary Policy Statement, also announced further tightening of the monetary policy to dampen the transmission of global inflation onto domestic prices. It does this by increasing “slightly the rate of appreciation of the policy band” of Singapore dollars relative to a bundle of foreign currencies.
This means that we would let the Singapore dollar appreciate instead of letting our domestic prices increase.
The logic is straightforward–domestic prices in Singapore are directly proportionate to global prices adjusted by the exchange rate. For example, the price for a kilogram of meat in Singapore would be the price of a kilogram of meat in the international market applied to the corresponding exchange rate.
In principle, to dampen the effect of increasing international prices on domestic prices, one can let the local currency appreciate. All things the same, the effect of increasing international prices will be absorbed via appreciation of the local currency, instead of being transmitted into local prices. However, with the appreciation of the Singapore currency, goods and services coming out of Singapore will be relatively more expensive than other countries.
The economic paths for both developed and developing countries have been tumultuous since the pandemic hit us. And within a matter of weeks, the global economy has been hit with a wave of severe shocks that can delay a full recovery for many nations.
The current environment of high global inflation and surging commodity prices may bring us back to a similar situation in the 1970s. Back then, the oil crisis fuelled a severe supply shock, and policymakers accommodated the supply shock by increasing aggregate demand.
This combination of factors had caused the episode of “stagflation”—a prolonged period of low economic growth, high inflation, and unemployment. There is high uncertainty in the world. Whether it is inflation or stagflation that comes knocking, policymakers and central bankers have to make ongoing adjustments to stabilise external shocks, maintain price stability and promote robust growth.
The article is an abridged version of the one first published in CNA.