Abstract

This paper provides an in-depth analysis of the exchange rate pass-through in the Singapore economy, allowing for the first time, asymmetric pass-through effects over the business cycle.  We find that the first stage exchange rate pass-through to domestic import prices is complete, with changes in the exchange rate fully reflected in domestic import prices by the fourth quarter of the shock.  The implication of this result is that the exchange rate provides an important buffer against external price pressures at the borders, especially in periods of escalating global commodity prices, thereby contributing significantly to the objective of medium-term price stability.  In comparison, the second stage pass-through, which involves the transmission of a change in domestic import prices to consumer prices, is more drawn-out.  Consequently, the overall exchange rate pass-through to consumer prices is fairly modest:  a 1% appreciation in the S$ Nominal Effective Exchange Rate (NEER) leads to a 0.1% decline in the domestic Consumer Price Index (CPI) in the short run and a 0.4% decline in the long run.  This finding is not unique to Singapore, as econometric evidence also points to subdued pass-through for many other industrial countries.  Our analysis also suggests the presence of asymmetric pass-through effects across the business cycle.  Amidst robust economic growth, importers tend to pass on a smaller share of the cost savings arising from a stronger exchange rate than when costs increase as a result of the weaker exchange rate during a downturn.  Retailers also tend to be more aggressive in passing on import cost increases in a phase of strong economic expansion.  The inference is that Singapore’s monetary policy needs to “lean against the wind” during a robust cyclical expansion that is accompanied by an increase in import costs.