© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

Discuss whether an increase in savings in Singapore will lead to problems in the

economy. [25]

Savings is the excess of disposable income over consumption expenditure. The

question on whether an increase in savings in Singapore will lead to problems in the

economy can be discussed in terms of the effects on the balance of payments, the national

income, unemployment and the general price level.

An increase in savings in Singapore may lead to a deterioration in the

balance of payments. The balance of payments is a record of all the transactions

between the residents of the economy and the rest of the world over a period of time and

is made up of the current account and the capital and financial account. Given any

amount of disposable income in Singapore, an increase in savings will lead to a decrease

in the consumption expenditure. When this happens, business sentiment in Singapore

may weaken which may lead to a decrease in the investment expenditure. Since a fraction

of the decrease in the investment expenditure in Singapore will be inward foreign direct

investments, the capital and financial account and hence the balance of payments will

deteriorate.

When savings in Singapore rises, the aggregate demand and hence the

national income may fall. Aggregate demand is the total demand for the goods and

services produced in the economy over a period of time and is comprised of consumption

expenditure, investment expenditure, government expenditure on goods and services and

net exports. The combined decreases in the consumption expenditure and investment

expenditure in Singapore will lead to a decrease in the aggregate demand and hence the

national income.

© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

In the above diagram, a decrease in aggregate demand (AD) from AD0 to AD1 leads to a

decrease in national income (Y) from Y0 to Y1. When aggregate demand falls, firms will

employ less factor inputs to produce less output and hence pay less factor income to

households. Household income and hence consumption expenditure will fall. Due to the

decrease in consumption expenditure, firms will employ even less factor inputs to

produce even less output and hence pay even less factor income to households.

Household income and hence consumption expenditure will fall further. Therefore, the

decrease in aggregate demand will lead to a larger decrease in national income and this is

commonly known as the reverse multiplier effect.

Since national income is equal to national output, the decrease in the national

income of Singapore due to the decrease in the aggregate demand will lead to a fall

in the demand for labour resulting in a rise in unemployment, assuming the size of

the labour force remains the same.

The decrease in the aggregate demand in Singapore will lead to a surplus of

goods and services and hence a fall in the general price level. In the above diagram, a

decrease in aggregate demand leads to a fall in the general price level (P) from P0 to P1.

When the general price level in Singapore falls, people may expect it to fall further. If

this happens, the consumption expenditure in Singapore will fall which will lead to a

further decrease in the aggregate demand.

An increase in savings in Singapore may lead to a decrease in the aggregate

supply. Aggregate supply is the total supply of goods and services in the economy over a

period of time. When savings in Singapore rises, the supply of loanable funds will rise.

Therefore, interest rates in Singapore will fall which will lead to a decrease in hot money

inflows and an increase in hot money outflows resulting in a decrease in the demand for

Singapore dollars and an increase in the supply of Singapore dollars. When these happen,

the Singapore dollar will depreciate. A depreciation of the Singapore dollar will lead to a

rise in the prices of imported intermediate goods in Singapore. Therefore, the cost of

production in Singapore will rise which will lead to a decrease in the aggregate supply.

The decrease in the aggregate supply in Singapore will lead to a larger decrease in the

national income and a larger rise in unemployment.

When savings in Singapore rises, the aggregate supply may rise less rapidly

in the long run. The decrease in the investment expenditure in Singapore will lead to a

less rapid increase in the production capacity in the long run, assuming the net investment

remains positive. Therefore, the aggregate supply in Singapore will rise less rapidly in the

long run. When this happens, assuming the aggregate demand in Singapore is rising,

which is the normal state of the Singapore economy, the national income will rise less

rapidly, unemployment will be higher and the general price level will rise more rapidly.

An increase in savings in Singapore will lead to a smaller multiplier which

may be undesirable for the Singapore economy. The multiplier is the number of times

by which national income increases due to an increase in autonomous expenditure. It is

inversely related to the marginal propensity to save. Therefore, when savings in

© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

Singapore rises, the multiplier will fall. When this happens, the effectiveness of demand-

side policies in Singapore will decrease which will make it more difficult for the

government to achieve the four macroeconomic goals of high economic growth, low

unemployment, low inflation and a balance of payments equilibrium.

An increase in savings in Singapore may not lead to problems in the economy. When households in Singapore decrease consumption expenditure, they will not only

purchase less domestic goods and services, but they will also buy less imported goods

and services. When this happens, the decrease in the imports of Singapore will lead to an

improvement in the current account and hence the balance of payments. If the aggregate

demand in Singapore and hence the general price level is rising rapidly, higher savings

may reduce the growth of the consumption expenditure and hence cool down the

overheating economy. Lower interest rates in Singapore will reduce the incentive to save

which will lead to an increase in the consumption expenditure. Lower interest rates in

Singapore will also lead to more profitable planned investments resulting in an increase

in the investment expenditure. When these happen, the aggregate demand and hence the

national income of Singapore will rise. Further, the increase in the investment

expenditure in Singapore will lead to a more rapid increase in the production capacity in

the long run, assuming the net investment is initially postive. Therefore, the aggregate

supply in Singapore will rise more rapidly in the long run. Singapore operates under the

managed float exchange rate system. Therefore, if the exchange rate of the Singapore

dollar is initially at the lower limit of the policy band within which it is maintained, the

MAS will intervene in the foreign exchange market to prevent it from falling. If this

happens, a fall in interest rates in Singapore will not lead to a depreciation of the

Singapore dollar. Therefore, the cost of production in Singapore will not rise and hence

the aggregate supply will not fall. A smaller multiplier may be desirable for the

Singapore economy. The Singapore economy is normally at or near the full-employment

equilibrium. Therefore, a smaller multiplier in Singapore will prevent any change in

autonomous expenditure from causing the national income to deviate dramatically from

the full-employment level.

In the final analysis, a rise in savings in Singapore is unlikely to lead to problems

in the economy. Due to the culture of thrift, the compulsory savings scheme and the

absence of a generous welfare system in Singapore, the savings rate is close to 50 per

cent which is already very high. Therefore, any increase in savings in Singapore is

unlikely to be significant and hence the effect on the consumption expenditure is likely to

be small. Further, the consumption expenditure in Singapore is a small component of the

aggregate demand due to the small population, the high savings rate and the high exports.

Therefore, the effects of a decrease in the consumption expenditure in Singapore on the

economy are likely to be small.