Main Factors of Inflation in Singapore

Inflation in Singapore is caused by both domestic and external demand-pull and cost-push factors. Singapore mainly suffers from demand-pull inflation, which may occur when increases in aggregate demand (AD) persistently exceeds that of aggregate supply (AS), which caused excess demand when the economy is near or at full employment. Inflation, in this case, is due to the rise in AD, which can come from the rise in C, I, G and (X-M), therefore causing the upward pressure on the general price level (GPL).

Singapore's major source of demand-pull inflation would be the rise in income of her trading partners, which lead to the increase in the purchasing power of households. This, in turn, causes greater an increase in the demand for Singapore’s exports. When there is a rise in Singapore net exports, her AD rises, leading to the rise in the GPL. This can be seen when countries like the US recovered from the 2008 global financial crisis. Being one of Singapore’s largest export market, when the US' national income rises, it will lead to the rise in the demand for Singapore’s export. With the value of Singapore’s exports being more than twice the size of her domestic economy, this will have a significant impact on the AD and hence GPL.

In addition, there might also be an increase in Foreign Direct Investment (FDI). This is not only because of the higher expected rate of return of investing in Singapore when external demand rises, but also that the multinational corporations (MNCs) which produce in Singapore tends to be export-oriented. An increase in FDI will lead to a rise in AD and an upward pressure on prices on the GPL.

Singapore can also face demand-pull inflation from domestic sources. For example, with the recovery of the Singapore economy after the financial crisis, the purchasing power of household rose. Together with the influx of foreign workers coming into Singapore, this also increased the domestic C and AD, and hence GPL rises.

A source of cost-push inflation in Singapore would be the increase in global demand for raw materials or commodities such as food and oil. This increases the unit cost of production as these raw materials are the important factor of production, causing the AS to rise upwards and therefore raising the GPL in Singapore, leading to cost-push inflation. For example in 2012, the average crude oil price was at historically high levels as the OPEC restricted their oil production. This was an important contributing factor to Singapore’s high inflation rate that year, as with little or no substitutes to the imported raw materials like oil, demand for her imports are price inelastic. GPL thus rises.

Another cause of Singapore’s cost-push inflation would be the government’s efforts to reduce the inflow of foreign workers. Tightening of foreign labour policies has led to the overall labour force to rise slower than the demand for labour, which results in a labour shortage. With the rise in wage rate and productivity growth lagging behind, unit cost rises. Hence AS shifts upwards and lead to cost-pull inflation.