Is the Budget Inflationary?

Even before the budget was announced last Friday, it was widely anticipated to deal with the thorny issue of inflation. Inflation in Singapore has reached multi-year highs. One of the contributing factors has been the rise in food prices. The price hikes of food and commodities could certainly have caused hardship for some Singaporean families, and also increased economic anxiety for all.

The highlight of the budget however is the return of much of the $6.4 billion surplus in the form of various rebates. For example, individuals are given growth dividends and also a one off 20 per cent rebate on their income taxes (capped at $2000). Furthermore, there are various handouts - particularly to poorer families - which all in all erased much of the budget surpluses.

Aggregate Demand

To fight inflation, policy makers should be crimping aggregate demand through tighter monetary conditions, tighter fiscal policies, or a combination of both. However, instead of reducing aggregate demand through higher tax collections, the government is in fact increasing the purchasing power of tax payers through the various forms of rebates.

The increase in disposable incomes through the rebates and handouts is expansionary since it will lead to increase in aggregate demand. Seen from a demand-supply perspective, this might even translate to higher inflation. The budget can therefore even be construed as inflationary, which means that it could be doing the economy more harm than good.

Inflation in a Small Open Economy

To truly understand the impact of the budget on inflation, one must first appreciate that Singapore is a small and highly open economy. Added to this is a highly flexible workforce, including the use of foreign workers and talent.

The first implication is that much of Singapore's inflation is imported. For example, oil and commodity prices - which have risen a lot over the past few years - are also not within Singapore's control. Since we are a small economy, our demand will have a negligible impact on world prices. The second implication is that the aggregate supply of Singapore is in principle is highly elastic. Flexibility in the labour market lessens the impact of wage-driven inflation. The conjecture here is that price-wage inflation spiral is less likely to take hold in Singapore.

The overall implication is that the budget - even though it is expansionary - will probably not give rise to too much inflationary pressures because we are a small, open and highly flexible economy. From this perspective, the objective of the budget is to help Singaporeans cope with the effects of inflation rather than fight it.