Inflation refers to a sustained rise in the general price level of all goods and services (e.g. housing, transportation, food and so forth). In other words, it also means the rising cost of living. The inflation rate is often calculated as the percentage increase in the consumer price index (CPI). Generally, some amount of inflation is necessary to ensure that an economy is healthy, otherwise no inflation would mean that there is no competitive demand for goods and services in the economy. A healthy inflation rate should lie between 1 per cent to 3 per cent where the central bank of each country would usually aim to achieve; a desired inflation rate which is specific to the size and needs of each economy.
Inflation higher than 3 per cent is called hyperinflation. An example of hyperinflation is the 6.5 x 10108 per cent inflation in Zimbabwe in 2008 where something that costs a dollar today, would cost two dollars tomorrow. Hyperinflation wipes out consumers’ savings and firms’ profit margin as wages could not possibly increase at the same speed. Foreign companies would think twice about investing in a country with hyperinflation as there is high uncertainty and difficulty in predicting future prices and costs. Exports would also decline drastically as imports are deemed cheaper than domestic goods and services. These negative factors adversely affects the growth of the economy in the long run.
There are usually two types of inflation: demand-pull inflation and cost-push inflation.
Demand-pull inflation is a sustained price increase that arises from an increase in aggregate demand. This type of demand-side inflation often occurs when the economy is or at near full employment. An increase in aggregate demand causes a short-term shortage which pushes up the general price level. Aggregate demand may increase due to an increase in any of its components such as consumer expenditure, investments, government spending, and net exports. Given this increase in aggregate demand, firms would also increase production which leads to an increase in demand for the factor inputs, resulting in a rise in price of raw materials as well. When this happens, the cost of overall production in the economy rises which firms would often push to consumers so as not to compromise on their profit margin. As such, the overall prices of goods and services in the economy rise on a whole.
One example would be how consumer prices in Singapore recently edged up in May from the previous month, according to figures from the Department of Statistics on Friday. The CPI measured at 1.4 per cent in May 2017 as compared with 0.4 per cent in April 2017. The Monetary Authority of Singapore (MAS) and the Ministry of Trade and Industry (MTI) had attributed this rise to be resultant from the pay-out of service and conservancy charges (S&CC) rebates to households. An increase in government spending often increases the spending power of consumers causing aggregate demand to rise as a whole. Of course, to reduce demand pull inflation, the government can use policies to reduce the growth of aggregate demand.
The second type of inflation is cost-push inflation. This supply side inflation is a sustained rise in the general price level due to a rise in the cost of production in the economy, independent of demand. Examples of cost-push inflation include workers bargaining for higher wages to maintain purchasing power when they expect future prices to increase. As labour costs form the largest component of total costs in Singapore, a sudden rise in wages can cause significant cost-push inflation in Singapore. When the cost of hiring a worker increases independently of demand, firms would increase prices at the same output levels so as not to compromise on their profit margin. Of course, external factors such as rising commodity prices, oil prices, exchange rates and foreign investments could be reasons why the general price level increases. To reduce cost-push inflation, the government can use policies to increase aggregate supply or reduce the growth of aggregate demand.
Both demand-pull and cost-push inflation are present in Singapore, but due to limited natural resources, Singapore is all the more subjected to imported inflation. This is especially so when Singapore’s exports is made up of imported inputs of production.
Imported inflation is the sustained rise in general price levels due to a rise in the prices of imports. Hence, the biggest threat to Singapore is the depreciation of its currency which can affect households directly. Singapore is after all a small economy that is highly dependent on external demand, where exports account for a large proportion of the aggregate demand. An appreciation of its currency at a fast pace would backfire as this would cause exports and aggregate demand to plummet.
Imported inflation is usually the key factor in affecting Singapore’s economy and is most likely the cause of inflation in Singapore, alongside with cost-push inflation and lastly, demand-pull inflation. In order to effectively manage the Singapore dollar, the Monetary Authority of Singapore (MAS) could control the money supply by potentially buying or selling the Singapore dollar to raise or lower its exchange rate.
Different types of inflations do exist and it does not mean that they are mutually exclusive from one another. Both types of inflation can exist, just like in the case of Singapore.