1. Why and how are the capital and current account tied together so closely?
In the balance of payment, current account and capital account are tied together by an accounting identity. Current account on one side and the capital and financial accounts on the other side should balance each other out due to the double entry of each transaction.
[ Current Account + Financial Account + Capital account + Official Reserve Account = 0 ]
For example, if a country has a positive capital and financial accounts, it will have a current account deficit - because the debit is more than the credit. It means that this country is borrowing and using other countries savings to meet its local investment ...view middle of the document...
The Singapore’s labor market was very tight and the economy operated at full employment.
In general, the real exchange rate is determined in long run by Purchasing Power Parity, Net Foreign Asset, Productivity, Trade Trends, and Saving-Investment balance. (Appendix 3)
Specifically, the real exchange rate of Singapore dollar was appreciating in the long run. The reasons for this long-term appreciation are:
* First: Singapore’s economic development and the transformation of the economy since the early 1980s; structural change in the economy, involving the evolution in economic activity from a predominantly low-skill, labor-intensive base towards greater capital and knowledge-intensive activity has meant a continuous shift in the basis of Singapore's competitiveness in international markets.
* Second: National thriftiness has led to large current account surpluses. Substantial public sector surpluses and the high private savings rate have led to persistent current account surpluses since the mid-80s.
3. How do exchange rates interact with trade balances and fiscal policies?
Trade Balance: trade balance equals exports minus import. Therefore, everything that affects export and import affects trade balance. Exchange rate effects the price of goods and services traded and therefore affecting the price of exports and imports. Higher export price than import one means a surplus in the trade balance and vice versa.
Fiscal Policy: fiscal policy is the use of government expenditures and revenue collection (taxation) to influence the economy. Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. If exchange rate depreciates the domestic goods become cheaper and this will increase the demand and lead to an increase in exports, reduction in economic growth and thus, achieve one of the government fiscal policies by the effect of exchange rate. Singapore’s rapid economic growth and industrialization played a key part in the sustained real appreciation of its currency prior to the Asian crisis. This appreciation came as result of persistent annual budget surpluses on the order of 12% of GDP. Economically this represented a withdrawal of funds from the domestic economy that created a need for obtaining capital from abroad to make up for shrinking liquidity. This in turn increased the value of the Singapore dollar creating deflationary pressure.
4. Evaluate the advantages and disadvantages of a fixed vs. floating exchange rate system given the structure of Singaporean economy?
Referencing to the Singapore three main necessities and economic objectives. (Appendix 1)
Advantages: the floating exchange rates system works as an automatic stabilizer for the value of the currency which helps in freeing the monetary and fiscal authorities to concentrate on internal objectives such as employment and economic...