Monetary Policy in Singapore and the Global Financial Crisis

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b1110

Challenges for the Singapore Economy

competitors but is allowed to float within an undisclosed policy

band determined by the MAS in order to absorb short-term market

volatility. A particular policy band for the TWS$ is identified twice a

year in April and October which will ensure price stability over the

medium term and the ‘monetary policy stance’ is communicated to

the public in an official Monetary Policy Statement (MPS). This can

be fine-tuned if necessary through a ‘crawl’ mechanism to prevent

the TWS$ from becoming misaligned if conditions change in the

period before the next policy announcement. The precise width of

the policy band and the weights used to calculate the TWS$ are not

released to the public but market participants and academics can

usually make reasonable guesses about them. This allows the MAS

some room to ‘surprise’ the market on a day-to-day basis to prevent

excessive speculation against the Singapore dollar.

Singapore’s decision to forego the use of traditional monetary

policy instruments, such as interest rates and monetary aggregates, is

a consequence of its extreme openness to international trade and cap-

ital flows and its desire to ‘manage’ the currency to some degree.

Because Singapore imposes negligible protection against imports

from the rest of the world and has little by way of natural resources it

must import most of what it needs and export to pay for it. As a result

it is a classic price taker in international goods markets and the com-

bined ratio of its exports and imports to GDP — a measure of

openness to trade — is in excess of three. What the MAS has done

since 1981 has been to turn this import dependence into a virtue by

taking advantage of the powerful link between the exchange rate,

import prices, and domestic prices. Because domestic prices are

largely determined by world prices for a given exchange rate, inter-

vention to appreciate the TWS$ effectively lowers import prices and,

subsequently, wholesale and consumer prices, as the effects of the

appreciation ‘pass-through’ to the domestic economy. On the other

hand, if inflation is not a threat and there is a risk the economy will

slow down or slip into recession, the TWS$ can be depreciated to

enhance export competitiveness. Empirical studies have shown that

the exchange rate is an effective instrument of monetary policy in

Singapore and bears a stable and predictable relationship with price

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