Word in the New$: Stimulus

Feb 11, 2017 04.00PM |
 

by Ryan Ong

PRESIDENT Donald Trump disappointed the markets last week, when his news brief failed to touch on expected stimulus measures. Last year, Japanese Prime Minister Shinzo Abe announced a USD$73 billion (SGD$103.7 billion) stimulus measure, in the vain hope he might actually convince a Japanese person to spend a yen someday. And with Singapore’s upcoming Budget 2017, business owners are probably hoping for policies that provide a stimulus. But what exactly is a stimulus?

 

What is an economic stimulus?

An economic stimulus can refer to any number of policies, which are used to kick-start a stalling economy.

While most of us like to think modern economies are smooth, self-correcting machines, the reality is quite different. In fact, most economies are less like well-engineered machines and more like your uncle’s 13-year old Nissan. When the inevitable stall occurs, the government is in charge of getting things going again. Some examples of how it can do that are:

  • Quantitative Easing
  • Controlling interest rates (not done in Singapore)
  • Tax cuts
  • Deficit spending

This isn’t an exhaustive list: governments can get quite creative. But when you read the word “stimulus”, it usually takes one of these forms.

 

1. Quantitative Easing

Quantitative Easing (QE) was used by the United States during the last Global Financial Crisis (2007 – 2008). This is a method of controlling the supply of money in a country. When there is more money circulating in an economy, people are better able to spend, banks are better able to lend and businesses can hire more staff. When the amount of money contracts, the opposite happens.

When a central bank uses this tactic, it typically purchases government bonds in large amounts. It may also purchase other assets, such as toxic bonds (bonds that are likely to be defaulted on) in order to prevent further financial damage. This raises the amount of cash in circulation and lowers interest rates. And as mentioned above, more borrowing and spending leads to more jobs and a recovering economy.

The danger of QE is that, if it’s maintained for too long, inflation will start to go out of control.

The more currency there is floating around, the less that currency can buy for you (e.g. if everyone earns $10 million a month, no one would sell you their prized Rolex for just $1 million). The prices of everything go up to reflect the increased “wealth”. At the same time, the country’s currency devalues, so servicing its debt becomes more expensive.

As such, most central banks will set requirements on when QE must stop. It’s often pegged to indicators such as employment levels, inflation rates, or exchange rates.

Singapore’s central bank, the Monetary Authority of Singapore (MAS), doesn’t like to fiddle with the Singapore dollar like this (see below).

 

2. Controlling interest rates (not done in Singapore)

This is related to QE (see above). When interest rates fall, it becomes easier and cheaper to borrow money. This will in turn stimulate spending, business expansion and ultimately, employment. For example, Japan is experimenting with a negative interest rate. Japan’s banks are charged for holding on to money, which prompts them to aggressively lend it out.

Following the Global Financial Crisis in 2008, America’s central bank (the American Federal Reserve) set interest rates to zero. This helped their economy to recover.

When it comes to MAS however, it has surrendered control of domestic inflation rates. This is because the value of the Singapore dollar is pegged to a basket of different currencies, and is allowed to change in a way that reflects its true market value. This approach precludes the use of messing with the interest rate.

 

3. Tax cuts

This is one of the main stimulus measures expected of President Trump, who made a campaign promise to impose large tax cuts. When taxes are reduced – be it in the form of income taxes, sales taxes, or corporate taxes – the amount of money floating around in the economy also increases.

Tax cuts are often a populist measure. Everyone loves them, but remember that governments make their money through taxes. Without those taxes, there’s no way to fund the civil service. Big tax cuts can then negatively impact police forces, fire departments, the military, government schools and hospitals, and so forth.

Tax cuts can also eat into social welfare, because magic elves don’t arrive at midnight to fund those. Tax cuts can mean the government lacks the cash to subsidise bus fares for senior citizens, has to give smaller grants for public housing, and has fewer scholarships for needy students.

(Of course, people who support tax cuts will insist it’s not their responsibility to pay for those things. They’re not a charity service).

Another problem with tax cuts is that the effects are not proportional and hard to predict. Cutting corporate taxes, for example, can mean well-paid senior managers get richer, while none of the benefits reach their employees.

 

4. Deficit spending

This is the hallmark of Keynesian economics, named after economist John Maynard Keynes. Keynes theorised that governments should spend more when times are bad. That’s a little counter-intuitive, since we’re used to thinking we need to save more when times are bad. But here’s how it works:

The government drives the coffers into further losses for a time, via deficit spending (i.e. spending more than it can collect in taxes). The government issues bonds, and then uses the money for a variety of projects. These can be major infrastructure projects, such as building new highways, or putting up public housing. These projects typically require a lot of manpower and supplies, which means employment will rise, and businesses will make more money.

The government can also fund new businesses, subsidise the cost of wage increases, or pump money into adult education subsidies to retrain obsolete workers. The general idea is the same: the government pours (borrowed) money into the economy, to raise employment and productivity. This continues until the economy recovers. We will know it is recovered when the loudest and most influential person in the room says it has.

 

Will we see stimulus measures in Singapore?

Budget 2017 is right around the corner and given the poor state of the economy, we just might. One upside to consider is that because Singapore is a well-connected economy, we often gain benefits from the stimulus measures of others. Back in 2011 for example, Singapore’s home loans pegged to the Swap Offer Rate (SOR) became extraordinarily cheap, as QE in America drove the SOR rate into negatives.

Some stimulus to the economy is much needed, as we haven’t recovered from the plunge in the oil and gas industry. Keep your fingers crossed.

 

Featured image by Pixabay user geralt. (CC0 1.0)

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