This article employs a vector autoregressive (VAR) model to investigate the supply-side causes of business cycles in the small open economy of Singapore. The supply shocks examined are oil price, foreign technology, labour supply, productivity and wage shocks. The empirical results suggest that external and domestic technology shocks are responsible for the bulk of short-term output movements, while labour supply shocks are more important in the long run. In contrast, oil price and wage disturbances play negligible roles in macroeconomic fluctuations. These findings support the view that Singapore business cycles are caused by both domestic and international factors.
Empirical macroeconomic research in recent times has sought to rediscover the causes of business cycle fluctuations in the industrialized economies. Studies in this vein are provided by, inter alia, Shapiro and Watson (1988), Blanchard and Quah (1989), Moreno (1992), and Karras (1994). These works employed a variant of the vector autoregressive (VAR) methodology to investigate the contributions of aggregate demand and aggregate supply shocks to macroeconomic fluctuations. Typical demand shocks consist of disturbances to the goods and money markets, while supply shocks include oil price shocks, technological disturbances, and labour supply shocks. A common finding shared by the studies is that supply shocks play an important role in the business cycle fluctuations of developed countries.
Notwithstanding the renewed interest in the subject, there have been only two published studies along the above lines on business cycles in the small open economy of Singapore. The first of these, by Makrydakis (1997), recovered generic demand and supply shocks from a bivariate VAR model estimated for output and inflation. The author found that supply shocks are the dominant source of the growth cycles - fluctuations in the growth rate of economic activity - experienced by Singapore during the last two decades. However, given the multitude of possible supply shocks and their differential impact on the economy, it is questionable whether a single aggregate supply shock recovered from the data can be meaningfully interpreted.
The second study by Choy (1999) explored the sources of macroeconomic fluctuations in Singapore through a six-variable structural VAR model, identified by Keynesian-style short-run restrictions. Of the business cycle shocks examined, three can be classified as aggregate demand disturbances and the remaining three as aggregate supply shocks. Choy (1999) showed that although demand shocks are important, supply disturbances accounted for more than half of short-run output fluctuations, thus suggesting that the latter deserve serious attention from researchers. This article, therefore, focuses on supply shocks buffeting the Singapore economy, but examines a larger number of supply-side factors which could be responsible for macroeconomic fluctuations than that considered in the earlier paper. Our emphasis on supply shocks also reflects the current popularity of the Real Business Cycle (RBC) theory.
Using VAR techniques again, our objective is to quantify the effects of supply shocks on key macroeconomic variables, in both the short and long run. The shocks we consider are oil price, foreign technology, labour supply, domestic productivity, and wage disturbances. Despite their obvious relevance to open economies, foreign productivity disturbances have not always been incorporated as a distinct class of business cycle shocks in the existing literature. This state of affairs is unsatisfactory in the specific case of the Singapore economy, with its high exposure to trade and investment flows. Hence, a notable feature of this paper is its consideration of international productivity shocks that are transmitted to domestic business cycles through technological spillovers and diffusion (for a theoretical …