How does MAS formulate its monetary policy?
This section explains the principles that guide MAS’ formulation of monetary policy and how these principles have been applied in the context of the BBC framework:
First, monetary policy should be targeted at achieving price stability over the medium-term.
Second, monetary policy should be well-understood and systematic.
Third, monetary policy should be forward-looking and focused on the medium term.
Fourth, monetary policy should take into account the effects of all other macroeconomic policies, although certain circumstances may require monetary policy to work in concert with other policies, such as during times of economic crises.
3.1 Why is Singapore’s monetary policy targeted at price stability?
First, monetary policy should be targeted at price stability as it matters for the welfare of households and businesses.
The welfare of households and businesses is enhanced when there is domestic price stability. Low and stable price inflation is a prerequisite for the efficient allocation of resources, and provides a conducive environment for sustained economic growth. It also protects the purchasing power of savings.
Second, monetary policy should be targeted at price stability as prices are ultimately what the central bank can influence in the long run.
In the short run, cost and price rigidities mean that MAS’ monetary policy has an effect on real aggregate demand, and hence, growth and employment. Indeed, this is one of the channels through which the exchange rate impacts domestic prices.
However, it is not the objective of monetary policy in Singapore to achieve a GDP growth or employment target. Instead, monetary policy responds in a countercyclical way to developments in the output gap and unemployment gap as they have a strong bearing on future costs and price dynamics in the economy.
If economic activity (GDP) rises above potential (a positive output gap), for example, it may be a precursor of rising wages and costs and thus, an acceleration of price inflation in the period ahead.
In the long run, MAS’ nominal exchange rate policy only has an impact on prices, as is the case with monetary policy everywhere. If the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) is kept too low, output would rise above the economy’s potential and eventually inflation would rise. Conversely, if the S$NEER is kept too high, a recession would result, and inflation would fall.
This neutrality of monetary policy is equivalent to other central banks having no influence over real interest rates and the key factors influencing growth in the long run, such as productivity.
Accordingly, Singapore’s exchange rate-based monetary policy cannot be used to target an undervalued real exchange rate to boost international competitiveness, GDP growth, net exports, or the external balance. (See Questions 5.1 and 5.2)
3.2 Why should monetary policy be systematic and well-understood?
Clear and systematic monetary policy formulation ensures that MAS’ exchange rate policy does not become an additional source of uncertainty and disturbance to the economy.
Moreover, it helps to maintain MAS’ credibility, which in turn reinforces the effectiveness of its exchange rate policy.
Monetary policy rules are one way of ensuring that the monetary policy formulation process is transparent and predictable.
Although MAS does not follow a rigid policy rule since a certain degree of (constrained) discretion is necessary to be able to deal with unexpected events, research has shown that MAS’ exchange rate policy settings are well-characterised by a modified Taylor Rule. The Singapore Dollar Nominal Effective Exchange Rate (S$NEER) responds in a counter-cyclical way to variations in the output gap and inflation. This, along with MAS’ long track record of ensuring low and stable inflation, has helped to anchor inflation expectations, which feeds back in a virtuous cycle to strengthen MAS’ credibility.
3.3 Why should monetary policy be forward-looking and focused on the medium-term?
The main reason why monetary policy formulation needs to be forward-looking is that, as in other countries, monetary policy in Singapore works with significant time-lags.
MAS’ econometric models suggest that the peak impact of a change in exchange rate policy on the economy occurs only after four to six quarters.
As a small, open economy, Singapore is also frequently buffeted by external shocks. Given the impossibility of calibrating and timing policy changes to exactly offset all shocks, and the long and variable lags in the transmission process, monetary policy that attempts to respond to every shock could add to economic volatility rather than reduce it.
Instead, MAS’ policy band allows the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) to adjust to small and transitory shocks. MAS typically looks past transitory shocks to the economy or temporary deviations in inflation, and focuses on establishing a trajectory for the S$NEER policy band that will bring core inflation closer to its historical average of just under 2% over the medium term.
3.4 Why should monetary policy take into account the effects of other macroeconomic policies? When should monetary policy work in conjunction with other macroeconomic policies?
MAS takes into account the effects of other macroeconomic policies so that it has a comprehensive view of all factors acting on inflation in the economy. Other macroeconomic policies that can affect aggregate demand, costs, as well as underlying price trends include fiscal policy and macroprudential policy.
There are also certain circumstances under which monetary policy works in conjunction with other macroeconomic policies. The two examples below illustrate.
First, in a severe economic downturn, a monetary policy response alone may not provide sufficient support to an economy. During the Global Financial Crisis, MAS eased monetary policy twice: reducing the rate of appreciation of the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) policy band to 0% in October 2008, and re-centring the policy band downwards in April 2009. At the same time, fiscal policy played a significant role in buffering the economy against the externally-led downturn: the FY2009 Budget provided for a $20.5 billion (8.2% of GDP) Resilience Package to save jobs, enhance the cash flow of firms, support families, and strengthen the economy’s long-term capabilities.
Having macroeconomic policies work in a complementary fashion during the crisis provided effective counter-cyclical support for the economy.
Second, when the global financial system is flushed with liquidity and capital inflows are strong, a boom in the interest rate-sensitive segments of the economy can lead to a rapid increase in credit and a build-up in inflationary pressures. In the aftermath of the Global Financial Crisis, unconventional monetary policies by the world’s major central banks drove interest rates in Singapore down to around zero per cent. This resulted in faster growth in credit for property purchases and a sharp rise in property prices that caused inflation expectations to rise and pass through to headline inflation.
MAS assessed that it was appropriate to tighten monetary policy in order to anchor inflation expectations amid rapidly rising inflation. However, policy was not tightened in an overly aggressive way, amid persistent weakness in the broader economy, and given that the exchange rate would not be effective in reducing price pressures in the housing and car markets.
Together with other government agencies, MAS chose to respond by introducing several macroprudential measures to cool the housing market, which served to safeguard financial stability and cap rising inflation expectations. This was a targeted approach that, combined with a modest and gradual appreciation of the S$NEER policy band, helped to secure overall macroeconomic and medium-term price stability in the economy.
3.5 Why doesn’t MAS target the exchange rate and the interest rate?
MAS is unable to target both the exchange rate and the interest rate because it has an open capital account, which means that international financial capital is free to move into and out of Singapore.
The ‘policy trilemma’ of open economy macroeconomics states that it is very difficult, if not impossible, for policymakers to ‘fix’ or ‘manage’ the currency and at the same time target a domestic interest rate vastly different from global interest rates if financial capital is free to cross borders.
For example, an economy with an open capital market that pegs its currency to the US$ typically has a domestic interest rate that moves one-for-one with the US federal funds rate. This is because attempting to target an interest rate significantly different from the US federal funds rate would result in capital inflows or outflows and accompanying foreign exchange market pressure that will eventually force the country to give up its peg.
Singapore does not run an exchange rate peg. However, the limits of setting a S$ interest rate that is inconsistent with MAS' targeted policy band for the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) and prevailing international financial market conditions are still binding.
For example, if MAS had tried to raise domestic interest rates significantly in the aftermath of the Global Financial Crisis to counter asset price increases, strong capital inflows would have driven the S$NEER beyond the upper bound of the policy band and would have caused inflation to fall to very low rates inconsistent with medium-term price stability.
3.6 When does MAS change the crawl rate or slope of the policy band?
The slope of the policy band is changed when MAS assesses that the trajectory of economic activity over the medium-term policy horizon is changing gradually.
A positive slope to the band is typically equivalent to a tightening of monetary policy, in the same way that other central banks, such as the US Federal Reserve, tighten monetary policy by raising their policy interest rate. An appreciating trajectory for the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) helps to contain inflationary pressures.
In comparison, following a negative shock to the economy that results in a lower trajectory of inflation, MAS may ease monetary policy by reducing the rate of appreciation of the policy band. The slope of the policy band has been set as low as 0%.
For example, the rate of appreciation in the S$NEER policy band was reduced in January and October 2015 before it was set at 0% in April 2016. This sequential easing in the monetary policy stance took place as the growth and inflation outlook softened.
Although MAS can theoretically set a negative slope to the S$NEER policy band in response to a weakening macroeconomic outlook, it has never done so in practice. From a market perspective, a negative slope could trigger entrenched market expectations of a weaker S$ and induce a self-reinforcing sell-off in the domestic currency. This could lead to financial and macroeconomic instability.
Instead, if economic conditions were to warrant it—for example, if inflation and growth fell sharply and a prolonged period of low or negative inflation was expected—MAS could re-centre the policy band lower.
3.7 When does MAS change the level at which the policy band is centred?
A more significant adjustment in monetary policy settings may be necessary if the outlook for growth and inflation changes abruptly and rapidly, and both are projected to have fundamentally shifted to a new path. In such instances, MAS may change the level at which the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) policy band is centred.
For example, MAS re-centred the mid-point of the policy band down in April 2009 after the Singapore economy went into recession in the last quarter of 2008, and inflation concomitantly fell sharply from 5.4% in Q4 2008 to 2.4% by January–February 2009. Moreover, MAS had lowered its projections for headline inflation for 2009 as a whole, from 2.5–3.5% to −1–0%, earlier in the year. This re-centring move in April 2009 followed the flattening of the slope of the policy band in October 2008.
By comparison, MAS shifted to a positive slope and simultaneously re-centred the policy band upwards in April 2010 following a strong rebound in Singapore’s GDP growth and the emergence of incipient inflationary pressures from both domestic and external sources.
As these examples suggest, the re-centring of the band can take place following a previous change in the slope of the policy band, or both of these moves can be implemented at the same time.
Decisions to re-centre the band are carefully formulated and communicated to maintain market stability and promote confidence among economic agents.
3.8 When does MAS change the width of the policy band?
The policy band is widened when there is a significant increase in the level of uncertainty about the future path of the economy and inflation, and MAS expects this uncertainty to persist.
A wider policy band allows more room for market-determined movements in the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) during the period of uncertainty.
An example of a widening of the policy band was in October 2001 after the terrorist attacks in the United States.
Constitution of the Republic of Singapore 
Bernanke, B S (2015), “Why are Interest Rates so Low?”, Blog post, Brookings Institution, March.
Engel, C (2017), “The Role of Exchange Rates in International Price Adjustment”, Macroeconomic Review, Special Feature B, Vol. XVI, Issue 1, April.
Friedman, M (1953) "The Effects of a Full-Employment Policy on Economic Stability: A Formal Analysis", Essays in Positive Economics, pp. 117–132, The University of Chicago Press
Friedman, M (1968) “The Role of Monetary Policy”, American Economic Review, Vol. 58, No. 1, pp. 1–17.
IMF (2018), “Estimating a Monetary Policy Rule”, Singapore – Staff Report for the 2018 Article IV Consultation, Appendix V, 27 July.
MAS (2016), “Singapore’s Monetary History: The Quest for a Nominal Anchor”, Macroeconomic Review, Special Feature A, Vol. XV Issue 1, April.
MAS (2016), “A Model-based Ex-post Evaluation of Singapore’s Monetary Policy”, Macroeconomic Review, Box C, Vol. XV Issue 1, April.
Menon, R (2015) “Macroeconomic Stability and Financial Stability: Uncomfortable Bedfellows?”, speech at the 39th Federal Reserve Bank of New York Central Banking Seminar, 8 October.
MOF (2016), “Understanding Singapore Government’s borrowing and its purposes: An Overview”.
Obstfeld, M, Shambaugh, J C, Taylor, A M (2005), “The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary Policies and Capital Mobility”, Review of Economics and Statistics, Vol 87 (3), pp. 423–438.