Inflation, Exchange Rate, and the Macroeconomy:

Transcription

1 SINGAPORE ECONOMIC POLICY CONFERENCE 2008 Inflation, Exchange Rate, and the Macroeconomy: ESU01 Model Simulations Tilak Abeysinghe SCAPE, Department of Economics National University of Singapore Choy Keen Meng Economic Growth Centre, Division of Economics Nanyang Technological University Gu Jiaying SCAPE, Department of Economics National University of Singapore Department of Economics National University of Singapore Nanyang Technological University

2 Motivation Commodity and oil prices have risen to record highs over the past two years due to speculation, increasing demand to help feed and clothe the world s growing population and for biofuels, and limited supply of agricultural and energy resources as a result of stagnant productivity, climate change and rising extraction costs This has led to the erstwhile public enemy number 1, inflation, rearing its ugly head din global leconomies, including Singapore Monetary policy question: can the MAS use the S$ exchange rate to offset these increases in world commodity and energy prices and what are the consequences for the macroeconomy? Our quantitative answers come from simulating a 62 equation quarterly macroeconometric model of the Singapore economy the ESU01 model 2

3 ESU01 Model Full documentation of the model is in the book by Abeysinghe and Choy, published by Routledge Hardback, 2007 Paperback, forthcoming

4 Foreign Price Shock Profiles Foreign price index (P f ) is a geometric average of PPI/WPIs of Singapore s major trading partners 0.9% average rise in each quarter 6% above baseline at the peak Foreign price shock dissipates after 7qtrs Oil price (P oil )isbrentspotcrude price 7.1% average rise in each quarter 50% above baseline at the peak Oil shock dissipates after 7 qtrs 4

5 NEER PolicyScenarios NEER (% appreciation) full offset partial offset no offset No offset: NEER stays on baseline path Partial offset: 1.4% average appreciation in each quarter Fulloffset: 2.6% average appreciation in each quarter NEER appreciation slowsdown after 7 qtrs 5

6 Import prices (P m ): Domestic Price Equations Δ ln P = Δln NEER 0.05Δln NEER 0.114Δln NEER 0.018Δln NEER 0.14Δln NEER m t t t 1 t 2 t 3 t 4 f f f f f Δln Pt 0.37Δ ln Pt Δln Pt Δln Pt Δln Pt 4 oil oil oil oil oil Δ P t Δ P t ΔP t ΔP t ΔP t 4 Consumer prices (CPI ): Δ ln( CPI) = Δ ln( CPI) Δln P 0.071[ln CPI 0.45ln P 0.55ln ULC ] 0.008dum98Q dum01_ GST m m NT t t 1 t t 1 We also assume that there is complete pass through of NEER changes to the prices of merchandise and service exports on account of price taking behaviour 6

7 Stylized Facts 15 YO OY Growth Rate es Pf NEER Pm CPI Import prices and foreign prices co move closely CPI changes reflect import price movements, albeit with lags of 2 3 qtrs The effects of NEER appreciation or depreciation are transmitted to import and consumer prices within 5 qtrs 7

8 Model Simulation Methodology Dynamic baseline solution over 36 quarters (control run) In no offset simulation run, subject P f and P oil to the price shocks described above and solve model again Recomputealternative ti solutions for endogenous variables under the exchange rate scenarios: partial offset in which NEER follows a modest appreciation trajectory full offset in which NEER rises considerably faster Calculate the % deviations of macro variables in the simulation run from their control paths 8

9 Transmission Mechanisms of Price Shocks 9

10 Impact on Domestic Prices and Inflation ULC (% deviation)

11 Variable Inflation Estimates NEER Scenario Time (quarters) P m No offset Partial offset Full offset CPI No offset Partial offset Full offset CPI No offset Partial offset Full offset

12 Impact on GDP and Exports Consumption (% deviation)

13 Sectoral Impact 0.5 Commerce (% deviation) Fin & Biz (% deviation) Trans & Comm (% deviation)

14 Growth Estimates Variable NEER Scenario Time (quarters) Real GDP No offset Partial offset Full offset NODX No offset Partial offset Service Exports Full offset No offset Partial offset Full offset

15 Impact on Employment and Wages 15

16 Variable Labour Market Estimates NEER Scenario Time (quarters) Employment No offset Partial offset Full offset Unemployment No offset rate Partial offset Full offset Real wage No offset Partial offset Full offset

17 TheSacrifice Ratio Policy dilemma: central bankers need to weigh benefits of stabilizing prices against costs of slowing growth Policy trade off can be measured by how much output is lost to reducing inflation by 1% point: Sacrifice ratio = = Cumulative loss in output Difference in inflation 36 no offset GDP GDP t = 36 t = 1 full offset 1( t t ) no offset full offset ( ΔCPIt ΔCPIt ) The macroeconometric simulations imply that the sacrifice ratio for Singapore is around 2, compared to about 3 4 for the US and an average of 2.5 for the OECD 17

18 Conclusions We have demonstrated that imported inflation on the scale witnessed recently can in principle be fully countered with a sustained appreciation of the NEER, even though this entails a slowdown in growth In terms of our scenarios, the MAS appears to have opted for a partial offset policy option since the tightening of the NEER in October 2007, supplemented by fiscal support schemes to cushion the most vulnerable in society from the effects of price increases The recent easing of monetary policy is welcome in view of the output cost of disinflation, a worsening external outlook and the retreat of food and energy prices. 18