Name the main causes of inflation and say which ones MAS policy can and cannot influence.
Farah works in an office in Singapore and rents her home. Lately she has been grumbling about three price rises: her rent is going up at lease renewal, the chicken rice near her office costs fifty cents more than last year, and her electricity bill jumped for a few months before it settled. She calls all three "inflation".
In everyday speech every price rise gets called inflation. Economists and MAS treat price rises as different kinds with different causes, and only some kinds respond to monetary policy. Telling them apart helps you judge whether a rise will last and whether anything MAS does will affect it.
Demand-pull inflation starts with buyers. Households, firms and government together want to spend more than the economy can produce, so sellers can raise prices without losing customers. It tends to show up when the economy is running hot: jobs are plentiful, wages are rising, people feel confident and there are queues at restaurants.
Demand-pull can also be local to one market. Farah's rent is an example. When more people want to rent flats than there are flats available, rents go up, even if the wider economy is calm.
Monetary policy can lean against economy-wide demand-pull inflation. In Singapore, tighter monetary policy means a faster-rising Singapore dollar. That cools foreign demand for Singapore's goods and services and slows the economy a little. It does far less for a single market such as rents, which depend mostly on how many homes are built and when leases expire, so a change in MAS policy is unlikely to make much difference to Farah's renewal.
Cost-push inflation starts on the seller's side. When a business's inputs get dearer (wages, premises rent, ingredients, energy), it passes some of the increase on to customers. The cause is the rising cost of making the product. Customers wanting more of it plays no part.
The chicken rice hawker near Farah's office faces higher costs for rice, chicken and cooking oil. Stall rental may have gone up too, and the assistant may be expecting a higher wage. The hawker responds by adding fifty cents to the price of a plate.
Cost-push is harder for a central bank to deal with, because cooling demand does not lower input costs. What policy can do is stop a one-off cost rise from spreading into other prices.
Singapore buys most of its food and nearly all of its energy from abroad. When global prices of oil, gas, grain or cooking oil rise, the increase flows through into the prices Singapore households pay. This is imported inflation, a form of cost-push that starts outside the country.
Farah's electricity bill is a case of it. Electricity in Singapore is generated mostly from imported natural gas. When global fuel prices rise, electricity tariffs follow after a delay, and when fuel prices fall, tariffs fall too. Her bill went up for a few months and then settled as fuel prices came back down.
MAS cannot change the world price of oil. Lesson 1.3, "What a stronger or weaker Singapore dollar does to you", showed that a stronger Singapore dollar buys more foreign currency per dollar, so imports cost fewer Singapore dollars. By letting the Singapore dollar strengthen, MAS can offset part of an imported price rise in Singapore dollar terms. This makes Singapore's choice of policy tool, the exchange rate, especially useful against imported inflation. Go back to Lesson 1.3 if you want to see that mechanism again.
Once people expect higher prices, their own behaviour pushes prices up. Workers who expect living costs to rise by several percent next year ask for pay rises to match. Employers who expect higher costs raise their prices sooner, before the costs arrive. Landlords who expect rents to keep climbing ask for more at renewal. Each of these decisions feeds the others, so inflation that began as a one-off jump in the oil price can turn into a habit.
This is a major reason central banks act early, since bringing inflation down is much harder once everyone expects it. When a MAS statement mentions inflation expectations or wage growth, it is watching for this self-reinforcing effect.
Many prices do not fit neatly into one category. The chicken rice is a mixed case, with imported ingredients, local wages and rent all pushing at once. The useful question is which cause does most of the work.
To sort a price rise:
Pick a price from your own spending that has risen over the past year. Work through the possible causes: demand-pull, cost-push, imported and expectations. Decide which cause does most of the work. If imported costs are the main driver, a stronger dollar and calmer global prices may ease the rise. If local demand or local costs are the main driver, expect the rise to be more likely to stay.
Now pick out a few prices from your own spending that have gone up over the past year and think about which story fits each one best.
Pick three prices you pay that have gone up in the past year. For each one, write down which cause of inflation explains it best.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).