Essay, Macro: Singapore's Multiplier and Financial Crisis
A two-sector economy has a large multiplier value while a four-sector economy like the Singapore economy has a smaller multiplier value.
a. Explain the multiplier process and suggest reasons for this difference in the size of the multiplier. (12) b. Assess the possible effects of an increase in the marginal propensity to save on Singapore's recovery from the recent global financial crisis. (13)
def The fiscal multiplier measures the extent to which national income increases in response to an increase in autonomous expenditure. It depends on the marginal propensity to withdraw (MPW), and is calculated as the reciprocal of the MPW. As MPW increases, a larger proportion of each additional dollar spent in the economy is withdrawn from the circular flow of income, leading to a smaller increase in the national economy.
multiplier explanation For example, given an autonomous increase in government expenditure of 100M due to expansionary fiscal policy, households employed by firms which contract for the government will earn higher income of 100M. Assuming MPW is 0.5, these households will in turn half of this higher income in consumption, which further increases the factor income of those in consumer facing industries by 50M, who then go on to spend 25M, and so on and so forth until withdrawals equals injections. The increase in government spending of 100M leads to an eventual increase in national income of 200M.
In a two sector economy consisting of only households and firms, there are no taxes by the government nor are there imports due to international trade, while in a four sector open economy with the government sector, taxes and imports constitute withdrawals, which increase the MPW. For instance, the Singapore economy has a high marginal propensity to import (MPM) due to the country's openness to trade as well as its lack of natural resources. The government further imposes taxes to fund government expenditure, which leads to a marginal propensity to tax. Hence, in a four sector economy, the multiplier is lower as the MPW is higher.
b) Assess the possible effects of an increase in the marginal propensity to save on Singapore's recovery from the recent global financial crisis. (13)
def The marginal propensity to save is defined as the proportion of income saved for each additional dollar of income. A higher MPS would make fiscal policy less effective, and may also lead to an increase in the amount of loanable funds, which lowers interest rates and make more funds available for investment.
thesis An increase in the MPS would hamper Singapore's recovery from the global financial crisis, as it limits the effectiveness of fiscal policy by increasing the MPW, which causes the multiplier to be lower.
eval However, the extent of this effect may be small, as Singapore already has a high marginal propensity to save due to the country's forced savings scheme. Also, consumption as a component of GDP is small as the country is very open and exports make up a big proportion of national income.
Given that the multiplier in Singapore is already small due to high MPS and MPM, the increase in the MPS may have a limited marginal negative effect on recovery. Another factor to consider is the ability of the Singapore government to execute fiscal policy. As Singapore generally has a healthy budget and many years of budget surpluses, it has more flexibility to increase expenditure to compensate for a smaller multiplier effect.
antithesis An increase in the MPS would lead to an increase in the amount of funds available for investment. This would aid recovery from the crisis as the increase in investment would lead to a rightward shift in the AD and lead to growth in income. In the long run, higher savings rates also lead to higher economic growth as the economic capacity of the country grows due to higher investment. This is illustrated by a rightward shift in the LRAS.
eval However, Singapore's interest rates are more determined by international flows of capital, which Singapore cannot control due to her small and open economy. As such, increased savings are unlikely to move interest rates down by much.
Also, investment in Singapore is driven more by the export facing industries, and investments are made based more on expectations of external demand rather than the domestic interest rate.
conclusion Given the nature of Singapore's economy, the extent of the effect of an increase in the MPS on both consumption and investment is likely to be small, and it is likely that Singapore's recovery from the crisis would depend more on global recovery leading to a boost in the economy's exports.
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