Executive Summary

1        Monetary policy in Singapore centres on the management of the exchange rate. There is no independent policy targets for either interest rates or money supply. This choice of monetary regime is based on the following assumptions:¹

(a)     Money supply is essentially endogenous, or adjusts passively, to economic activity. Changes in money supply thus have a limited impact on economic activity, both in real and nominal terms;

(b)     Exchange-rate changes have a major influence on inflation, and not insignificant effects on the international competitiveness of the real sector;

(c)     An exchange rate-centred monetary regime in Singapore cannot co-exist with an independent policy on domestic money supply or interest rates; i.e., the active management of the exchange rate implies a loss of domestic monetary autonomy in the context of an open economy.

2       The present paper examines the first of these precepts, item (a). There is good economic reasoning stemming from the extreme openness of the economy, for the view that money supply has little independent influence on economy activity. The dominance of external demand in the economy implies a minimal role for changes in the domestic money supply as an independent stimulus of demand. The heavy reliance on foreign investments also reduces the role of domestically funded capital expenditures. Finally, the high exposure of the monetary sector to capital flow from abroad implies that any excesses in the demand or supply of money would be eliminated with only small changes in interest rates.

3        However, these arguments need to be tested empirically on the data.²  They are premised on the empirical dimension of economic behaviour including, the degree of wage and price flexibility, the elasticity of aggregate demand to interest rates, and the stability of the money demand relationships. This paper proposes to examine the linkages between monetary aggregates and economic activity in Singapore.

4       The paper begins with a discussion of some methodological issues relating to the money-income relationship. We explain that a consensus has emerged in the theoretical literature for the view that money affects the level of real economic activity over period of one or two years, but that it has no long-run impact on the economy. The empirical literature specifies a somewhat weaker criterion on establishing money-income relationships. Here, the emphasis is on deriving information content, specifically, whether fluctuations in monetary aggregates can help predict future movements of income, that are not already predictable on the basis of past values of income or other readily observable variables.

5       The paper proceeds with a careful empirical investigation of the money-income relationship in Singapore over the period 1976 to 1997 using the empirical criterion. We take into account the statistical properties of the money and income variables. Our objective is to confirm the robustness of results, and in this regard, we estimate a number of different test specifications, which vary across sample periods, conditioning variables used, and lag structure between the income and money variables.

6       Our results confirm that money (the M2 measure) and interest rates have predictive content for future movements in real GDP, though this relationship establishes itself only after a lag of about three to seven quarters. It is important to emphasise that our findings do not provide evidence for the non-neutrality (or otherwise) of monetary aggregates in Singapore. Instead, it suggests the possible use of information in monetary and interest rate variables in predicting future movements in real GDP. In addition, our findings provide a strong basis to proceed with a further study into identifying and quantifying the channels through which monetary impulses impact on key sectors and expenditure categories in the economy.

¹       See Teh and Shanmugaratnam(1992).

²       Several other papers have looked at the issues raised by    assumptions (a) and (c). For example, see Robinson, E. and Ng, C.H. (1996), on issue (a), and MAS Economics Department (1998), on issue (c).