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Singapore’s successful monetary policy turns 40

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Singapore’s successful monetary policy turns 40

Managing monetary policy in a small open economy is never easy. EFG’s Chief Economist Stefan Gerlach looks at the Monetary Authority of Singapore’s successful “crawling peg” regime, which this year turns 40.

Stefan Gerlach
Stefan Gerlach

Much attention is paid to how central banks in large economies set monetary policy. Such economies are relatively closed and therefore not much affected by economic developments and disturbances abroad. But most central banks operate in Small Open Economies (SOEs) in which the exchange rate often plays a dominant role in determining economic outcomes. A sharp, unexpected exchange rate change can plunge the economy into recession or lead to a burst in inflation. Indeed, while flexible exchange rates are often thought of as shock absorbers, the experiences of SOEs is often that they function as shock generators. 

Singapore’s “crawling peg” 
Since 1981, Singapore has very successfully followed an intermediate policy strategy. Much like a fixed exchange rate regime, the strategy reduces the risk of damaging short-term fluctuations in the exchange rate. But like a floating exchange rate regime, it allows the Monetary Authority of Singapore (MAS) to gear policy to domestic considerations. 
The crawling peg regime is focused on the Nominal Effective Exchange Rate (NEER) of the Singapore dollar as the intermediate target of monetary policy. The idea is that by steering the NEER, the MAS can achieve a desirable balance of inflation and economic activity in Singapore. While the MAS has good control of the exchange rate, it cannot precisely control it day-to-day. It therefore allows the exchange rate to move within a band around the target. 
Since the objective of the MAS’s monetary policy is “to maintain price stability conducive to sustained growth of the economy,” the NEER has been allowed to appreciate gradually over time to limit inflation in Singapore.  The average rate of appreciation of the NEER can be estimated by studying the time periods during which the desired rate of change of the NEER was positive. Doing so gives an estimate of the average rate of appreciation of about 1.5% per year. 


The way in which the MAS manages the exchange rate is unique, and reflects the exceptionally high import content of spending in Singapore. Thus, exchange rate changes have immediate and powerful effects on inflation and macroeconomic conditions more broadly. 
To manage policy, the MAS has three choices to make.

  1. Decide how quickly the target evolves over time, that is, the “rate of crawl.” 
  2. Whether it would be desirable to shift the entire target band. 
  3. Determine the width of the band around the target. The MAS allows the exchange rate to deviate from the target within a band, whose width need not be constant. 

Keeping the exchange rate in the band 
Despite the fact that the MAS does not provide detailed technical information regarding the exchange rate objective, market participants are well positioned to deduce the main features of the system in real time. Since the MAS has operated the system very successfully for 40 years, it has an exceptional track record and credibility. Thus, if the exchange rate strays from the target, limited intervention in the foreign exchange market is sufficient to signal to market participants that the MAS believes that the exchange rate has moved too far, and to nudge it towards the desired level. 

MAS conduct of policy 
So how has the MAS conducted monetary policy? Focussing on the period 2000 to 2020, the figure below shows the rate of growth over 4 quarters of the NEER (taken here as the measure of the stance of monetary policy) with inflation and the output gap. The figure shows that the MAS lets the NEER strengthen when inflation is relatively high and the output gap is positive (real GDP exceeds potential). 


These impressions are supported by estimates of a so called “reaction function,” according to which the MAS sets its policy variable as a function of the rate of inflation and the output gap. The estimates shows that a 1% increase in inflation or rise in the output gap leads to an 0.2% higher rate of growth of the NEER in the same quarter, and about a 0.6-0.7% permanently higher growth rate of the NEER if the increases in inflation and the output gap were permanent.

Inflation control 
Given the focus on price stability in the MAS’s mandate, the MAS has allowed the NEER to appreciate gradually over time. Using data on CPI inflation in Singapore and the real and nominal effective exchange rate, it is possible to compute a weighted average of inflation in Singapore’s trading partners. Over the period 1995-2020, it averaged 2.4% per year. In contrast, inflation in Singapore averaged 1.4%. While inflation in Singapore, as in many other countries, experienced sharp gyrations around the time of the Global Financial Crisis and afterwards, it has generally been below 2%.
The next policy meeting will take place in October. Whether the MAS will change its policy stance will depend on whether inflation rises more strongly than is currently expected. In turn, that will depend on how the Covid-19 pandemic evolves, which, at the moment, is anybody’s guess.

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