Effect of a Global Slowdown and Higher Interest Rates on Singapore

Answer

The slowdown in global growth and the rise in US interest rates both act on Singapore through aggregate demand, with a combined contractionary effect on its macroeconomic goals.

Slowdown in global growth. A fall in global growth has a negative contagion effect on a small, open economy. Assuming Singapore’s exports have positive income elasticity of demand, foreign demand for them grows more slowly or falls, so net exports (X) weaken. The pessimistic outlook also erodes consumer and investor confidence, lowering consumption (C) and investment (I).

Higher US interest rates. Singapore is an interest-rate taker: a higher US rate pulls the domestic rate up. A higher interest rate is contractionary — the cost of borrowing and the opportunity cost of spending rise, so consumption falls; and fewer investment projects clear the higher hurdle, since investment proceeds only where the marginal efficiency of investment exceeds the interest rate, so investment falls.

Combined effect. With X, C and I all falling, aggregate demand falls from AD₀ to AD₁, and the reverse multiplier amplifies the fall in real national income — Singapore experiences slower or negative actual growth. As output falls, firms face unplanned stock increases and cut production, hiring fewer factors of production including labour, so demand-deficient unemployment rises. With aggregate demand lower, the general price level eases, relieving demand-pull inflation. Finally, as export demand falls, export revenue falls and the balance of trade worsens. All four internal macroeconomic indicators are thus affected.