Singapore: Selected Issues

This Selected Issues paper assesses the stability of Singapore’s banking system in a regional context. It proposes a novel methodology for gauging domestic financial stability. The paper assesses the impact of fiscal measures on macroeconomic activity, and analyzes the effects of monetary policy using structural vector autoregressions. Estimates show that the Monetary Authority of Singapore’s exchange rate-centered framework is well suited to shape monetary decision making, given the large impact that changes in the nominal exchange rate have on activity and prices.

Abstract

This Selected Issues paper assesses the stability of Singapore’s banking system in a regional context. It proposes a novel methodology for gauging domestic financial stability. The paper assesses the impact of fiscal measures on macroeconomic activity, and analyzes the effects of monetary policy using structural vector autoregressions. Estimates show that the Monetary Authority of Singapore’s exchange rate-centered framework is well suited to shape monetary decision making, given the large impact that changes in the nominal exchange rate have on activity and prices.

III. Effectiveness of Fiscal Policy in Singapore 1

Singapore’s policy makers have often relied on fiscal policy to counter the impact of adverse external shocks. Against the background of the current uncertain external environment, this chapter analyze the effectiveness of fiscal policy in managing the economic cycle in Singapore. Empirical results based on a structural autoregression framework suggest that fiscal policy can be used as a counter-cyclical tool, but that the impact of fiscal policy is relatively short-lived and cumulatively small. This may reflect a number of factors, including the absence of credit-constrained economic agents, a high propensity to save among households, the use of quasi-fiscal measures not captured in budgetary data, a monetary focus on price stability, and leakages due to the openness of the economy.

A. Introduction

1. The effectiveness of fiscal policy as a counter-cyclical tool is the subject of a longstanding debate among economists.2 Supporters of an active role for fiscal policy suggest that economies lack an efficient mechanism to return to full potential. Critics, on the other hand, argue that economic agents could offset the impact of fiscal policy on aggregate demand through changes in their savings behavior. A middle-of-the-road view holds that fiscal policy can be effective provided certain conditions hold, including sound macroeconomic fundamentals, nominal wage and price stickiness, imperfect competition, and/or economic agents with finite horizons and liquidity constraints.

2. Singapore has often used fiscal policy to counter adverse external shocks. In the aftermath of the Asian crisis (1998), the bursting of the tech-bubble (2001), and the SARS shock (2003), the authorities used fiscal policy to help cushion the impact on economic activity and vulnerable groups. The fiscal counter-measures focused on relief for both businesses and households, including through tax incentives, tax credits, transfer payments, and various rebates on housing and utilities.

3. In the context of the current uncertain external environment, the chapter analyzes empirically the effectiveness of fiscal policy in Singapore. Fiscal multipliers are estimated using a structural vector autoregression (SVAR) framework. The chapter is organized as follows: Section B looks at the cross-country evidence on the effectiveness of fiscal policy; Section C presents the empirical approach (elaborated in the Annex) and results for Singapore; and Section D concludes.

B. Cross-country Evidence on the Effectiveness of Fiscal Policy

4. The question of the effectiveness of fiscal policy is ultimately empirical. There is a vast literature on this topic. Studies generally support the role for counter-cyclical measures, but evidence on the size of fiscal multipliers is uneven:

  • Event-studies give mixed results. The 2001 income tax rebates in the United States are generally considered to have been effective in boosting domestic demand, although the impact on output was relatively small with multipliers well below 1 (Shapiro, et al.(2002, 2003)). The 1995 stimulus package in Japan is estimated to have been successful in the short term, but it did not have a lasting impact on economic activity (Posen (1998), Mühleisen (2000)). However, Finlands response to the 1991 output shock, by letting automatic stabilizers operate fully, is considered to have been largely ineffective because it raised concerns about fiscal sustainability (Corsetti and Roubini (1996)).

  • Studies on advanced economies using vector autoregressive (VAR) methods conclude that fiscal multipliers have declined over time and, in some cases, may even have been negative (see Perotti (2005) for an overview). These results (Figure III.1), which differ widely across countries, likely reflect: (i) more leakage through the trade channel due to increased openness of economies; (ii) a decline in the share of liquidity constrained households due to better access to credit; and (iii) a sharper focus of monetary policy on price stability.

  • Estimates from macro models, on the other hand, show that fiscal policy can be quite effective (Figure III.1). Impact multipliers are in the range of 0.3 to 1.2 percent upon impact. Furthermore, expenditure measures appear to have a larger effect than tax measures (Hemming and others 2002, Botman 2006). However, the size of the estimated multiplier depends on assumptions about parameters such as labor supply elasticities and the pervasiveness of liquidity constraints.

Figure III.1.
Figure III.1.

Fiscal Multipliers from SVAR and Macroeconometric Models - Cross-country Evidence

Citation: IMF Staff Country Reports 2008, 281; 10.5089/9781451834284.002.A003

Source: Perotti (2005).

5. Generally, the cross-country evidence suggest that the success of fiscal policy iscontingent on a number of factors. First, the fiscal response needs to be well-timed. This will tend to increase the effectiveness of fiscal policy in countries with short implementation lags and/or large automatic stabilizers (the latter being the first line of defense). Second, strong fundamentals, including macroeconomic stability and fiscal sustainability, will strengthen multiplier effects by lowering any possible offsets from precautionary savings. Finally, fiscal measures need to be well-targeted to ensure the largest possible demand impact.

C. Effectiveness of Fiscal Policy in Singapore

Empirical Approach

6. VAR methods are standard in monetary policy analysis, but have only recently been applied to fiscal policy. This chapter does so by applying the SVAR methodology developed in Blanchard and Perotti (2002).

7. Intuitively, this methodology utilizes the (“inside”) lags in fiscal policy to identify discretionary structural fiscal shocks and their impact on economic activity:

  • Assuming that discretionary fiscal policy decisions take time to be implemented (because of political and legislative requirements), the short-term (i.e., within one quarter) reaction of fiscal variables to current economic developments only reflect “automatic” responses defined by existing laws and regulations.

  • Fiscal developments adjusted for these automatic/cyclical responses are, therefore, assumed to represent discretionary structural fiscal policy shocks.

  • In simulations, these structural shocks are used to quantify the response of real economic variables to discretionary fiscal policy. In the case of Singapore, the focus is on private domestic demand, in part to abstract from first-order leakages.

A technical description of the methodology is presented in the Annex to this chapter.

Empirical Results

8. Empirical results suggest that discretionary fiscal policy can have an immediate impact on private domestic demand and play a role as a counter-cyclical tool. However, the impact drops off quickly and eventually turns negative (Figure III.2 and III.3), leaving the cumulative effect relatively small compared to other countries. The estimated impulses are generally not significant past the fourth quarter. By aggregate demand component, the estimated impulse response functions (not shown here) suggest fiscal policy appears to have a larger impact on private investment than on private consumption. This may reflect a high precautionary savings-motive among Singaporean households and a government strategy of partly focusing discretionary measures on strengthening household savings.

Figure III.2.
Figure III.2.

Singapore: Fiscal Multipliers in Singapore - SVAR Results

Citation: IMF Staff Country Reports 2008, 281; 10.5089/9781451834284.002.A003

Source: Staff estimates
Figure III.3.
Figure III.3.

Cumulative Multipliers - Model 1

- Cumulative impact on private demand from a fiscal expansion of 1 S$

Citation: IMF Staff Country Reports 2008, 281; 10.5089/9781451834284.002.A003

Note: The cumulative multiplier at a given quarter equals the ratio of the cumulative response of private demand and the cumulative response of the fiscal variable.

9. Changes in revenues are estimated to have the largest impact-effect on private demand, but that impact fizzles out quickly. This is in contrast to results obtained for a number of other industrial countries, which tend to show a larger multiplier for expenditure measures. However, the puzzle could in part be explained by the narrower definition of government expenditure used here, which excludes key income transfers for lack of quarterly data.

10. Among expenditure components, the simulations show that changes in government current spending provides more stimulus than changes in public investment. Indeed, the estimates for investment multipliers are generally insignificant. This may reflect some crowding out of private investment activity.

11. A fiscal expansion has a positive but limited impact on inflation. The largest impact is related to changes in taxes, which is consistent with the estimated larger impact on private demand (and hence inflation pressures) from changes in government revenues. Government spending, on the other hand, does not appear to have a significant impact on prices.

D. Concluding Remarks

12. Singapore’s large fiscal reserves provides ample scope to use fiscal policy to counter adverse external shocks. Given Singapore’s relatively small automatic stabilizers, a counter-cyclical response—when needed—would have to be primarily discretionary.3 However, the short fiscal lags allow for a fast response to changing economic conditions. In an uncertain external environment such as today’s, this flexibility provides some insurance against further negative spillovers from a more pronounced deterioration in the global economy.

13. Preliminary results suggest that fiscal policy in Singapore can serve as a tool for demand management, but cumulative fiscal multipliers are generally found to be small. This may reflect a number of factors, including:

  • The absence of credit-constrained households, leading to a somewhat lower consumption response, on the margin, to changes in disposable incomes;

  • A high propensity to save among households—possibly, in part, reflecting the absence of a more comprehensive social safety net;

  • The use of nonbudgetary measures, including changes in contributions to the mandatory public savings scheme (CPF), to stimulate activity. These are not captured in the fiscal variables used in this study;

  • Strong monetary focus on price stability, which may partly offset the effect of fiscal stimulus;

  • Significant leakages through trade as well as remittances (nonresident workers account for around 30 percent of the labor force), which may weaken the dynamic interrelations between domestic demand components.

14. This analysis could be expanded. It could be useful in future research to analyze the impact of more disaggregated fiscal measures on private demand and its sub-components, which could help strengthen fiscal design. A study of the impact of income transfers would be particularly desirable, since they are often used as a counter-cyclical as well as redistributive tool. Finally, the results could be subjected to sensitivity analysis, including with respect to the assumed expenditure and revenue elasticities. All these potential extensions remain on the research agenda.

Annex III.1. Technical Description of the Fiscal SVAR Framework

The basic VAR specification is:

(1)zt=Γ(L)zt-1+ut

where zt is a nx1 vector of endogenous variables, Γ(L) is a nxn matrix of lag polynomials in the lag operator L and ut is a nx1 vector of reduced-form innovations, which are independent and identically distributed. The relation between the reduced-form innovations ut and the objects of ultimate interest, the structural shocks vt, can be represented as:

(2)Aut=Bvt

where the nxn matrices A and B describe (i) the instantaneous relation between the variables and (ii) the linear relationship between the structural shocks and the reduced form residuals, respectively. The structural shocks are assumed to be orthogonal, which allows for impact analysis of an isolated shock. The structural form of the VAR can be obtained by multiplying (1) by A and using the relation defined in (2):

(3)  Azt=(L)zt-1+Aut=(L)zt-1=Bvt

Solving (3) for zt yields the structural specification:

(4)zt=[I-Γ(L)L]-1A-1Bvt

Where I is a nxn identity matrix. In the simplest specification used in this study, zt = [yt et rt] consists of three variables for Singapore: real private domestic demand, yt; real government expenditure (consumption and investment), et; and real current government revenue, rt. 4 The data used are seasonally adjusted and at a high frequency (quarterly) in order to identify the structural shocks. The VAR is estimated in log levels with a constant, time dummies, and G7 growth added as exogenous explanatory variables. The number of lags chosen is five as suggested by Akaike and other information criteria.5

Estimation basically proceeds in four steps. In the first step, the reduced form VAR is estimated, yielding the reduced form residuals ut=[utyuteutr]:6

(5)uty=aeyute+aryutr+vty
(6)ute=ayeuty+βrevte+vte
(7)utr=ayruty+βervte+vtr

As suggested by Perotti (2005), the innovations in uteandutr can be thought of as linear combinations of three types of shocks: (i) the automatic or cyclical response of expenditures and revenues to innovations in private domestic demand; (ii) the systematic response of fiscal policy to same—period macro shocks; and (iii) discretionary fiscal policy shocks, which are the structural shocks we are interested in identifying. This gives the following representation of the reduced form residuals for the fiscal variables:

(8)ute=ayeuty+βrevte+vte
(9)   utr=ayruty+βervte+vtr

where vteandvtr are the structural shocks to government expenditure and revenues, respectively. Since fiscal policy is implemented with a lag, systematic discretionary responses to macro shocks (i.e., item (ii) in the previous paragraph) are absent in quarterly data. As a consequence, the coefficients ayeandayr a in (8) and (9) only capture the automatic/cyclical response of fiscal variables to economic activity.

Given that the reduced form residuals are correlated with the structural shocks, exogenous elasticities are used to estimate the automatic/cyclical response of the fiscal variables.7 With these, one can then construct the cyclically adjusted fiscal shocks, which constitutes the second step of the estimation procedure:

(10)ute,adj.ute-ayeuty=βrevtr+vte
(11)utr,adj.utr-ayruty=βervte+vtr

In the third step, the structural fiscal shocks are determined. Assuming that structural revenue shocks have no impact on structural spending shocks, (10) and (11) become:

(12)ute,adj.=vte
(13)utr,adj.=βervte+vtr

The structurally adjusted expenditure shock is, consequently, equal to the cyclically adjusted expenditure shock. With this, it is now possible to estimate the response of revenues to structural expenditure shocks, βer, using simple OLS.

In the fourth and final step, the coefficients in the equation for private domestic demand residuals (5) can be determined. Combined, the four steps, which are effectively done simultaneously, allow us to estimate the A and B matrices presented in (2):

[1-aeyary-aye10-ayr01][utyuteutr]=[1000100βer1]  [vtyvtevtr]

In turn, these are used to compute the structural impulse responses of private domestic demand to discretionary expenditure and revenue shocks.

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1

Prepared by Leif Lybecker Eskesen

2

See IMF World Economic Outlook, April 2008.

3

Singapore does not have a comprehensive unemployment benefit scheme and corporate taxes are assessed based on previous year’s income.

4

Quarterly data for special transfers were unfortunately not available and are, therefore, not included in the expenditure data.

5

The models specified in this paper are robust to alternative specifications and residuals do not appear to suffer from autocorrelation. Tests for normality of error terms suggest there is not an issue with skewedness, but they cannot reject the hypothesis that there may be an issue with kurtosis.

6

Representation of the exogenous variables are excluded here to allow for a simplistic illustration of the model.

7

For Singapore, the elasticity of expenditures with respect to changes in economic activity is assumed to be close to zero within the quarter, as commonly assumed in many other empirical studies. The elasticity of revenues is estimated at around ½ percent within the quarter. The relatively low number partly reflects that corporate taxes are based on past year’s rather than contemporaneous earnings, leaving taxes less responsive to contemporaneous changes in economic activity. While the parameterization is plausible, the magnitude has implications for the estimated multipliers.

Singapore: Selected Issues
Author: International Monetary Fund
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    Fiscal Multipliers from SVAR and Macroeconometric Models - Cross-country Evidence

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    Singapore: Fiscal Multipliers in Singapore - SVAR Results

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    Cumulative Multipliers - Model 1

    - Cumulative impact on private demand from a fiscal expansion of 1 S$