When our coffeeshop Kopi and Teh increase in price and Daiso no longer costs $2, we know for sure that Singapore is feeling the effects of rising inflation. For February 2022, the CPI-All Items inflation rose to 4.3%, while the MAS Core Inflation was 2.2%.
The Monetary Authority of Singapore (MAS) has been keenly watching the rate of inflation and has made recent changes to Singapore’s exchange rate-based monetary policy: 1. “re-centre the mid-point of the exchange rate policy band at the prevailing level of the S$NEER” and 2. “increase slightly the rate of appreciation of the policy band”.
So what do these monetary policy actions MAS have taken really mean and what more can MAS do to help Singaporeans cope with inflation?
The Mandate Of MAS Is Price Stability
The Monetary Authority of Singapore is Singapore’s central bank, and its key objective is maintaining price stability conducive to the sustained growth of the economy. This is not just a policy objective but is actually enshrined in the MAS Act.
While MAS does not set an explicit target for price stability, MAS has concluded that a core inflation rate of just under 2%, which is close to its historical mean, is consistent with overall price stability in the economy.
As core inflation has recently risen to above 2% for consecutive months, it is unsurprising that MAS has made its recent policy moves.
MAS Moderates Inflation Through Exchange Rate
For Singaporeans, the exchange rate, directly and indirectly, affects a wide range of prices in Singapore, such as import and export prices, wages and rentals, consumer prices and output prices.
As Singapore is a small and open economy, our monetary policy is centred around the management of the exchange rate. This is because the exchange rate has a much stronger influence on inflation than the interest rate in Singapore. Our gross exports and imports of goods and services are more than 300 percent of GDP and domestic expenditure has a high import content. Almost 40 cents of every dollar spent domestically is on imports.
In fact, MAS has based our monetary policy on the exchange rate since 1981 and it is our only form of monetary policy. Our capital markets are open and domestic interest rates are largely determined by global interest rates and foreign exchange market expectations of the Singapore dollar. This is unlike other central banks which may use other monetary policy tools such as setting interest rates or controlling of money supply.
Specifically, MAS moderates inflation by managing the Singapore dollar nominal effective exchange rate (S$NEER), which is managing the Singapore dollar against a trade-weighted basket of currencies.
MAS Manages The Singapore Dollar Nominal Effective Exchange Rate (S$NEER) In 3 Ways
Instead of managing the Singapore dollar against a single foreign currency, the MAS focuses on the S$NEER, as the trade-weighted exchange rate better reflects Singapore’s diverse trading patterns. The S$NEER also tends to be more stable than bilateral exchange rates, as it is not unduly affected by idiosyncratic factors in any single economy.
Instead of making frequent changes to the S$NEER every time there is an external shock or economic volatility, the S$NEER is allowed to float within this policy band that is set around the targeted appreciation rate.
There are 3 ways the MAS can manage the S$NEER and thus its consequent effect on inflation:
- Adjust the slope or rate of appreciation for the S$NEER
- Adjust the midpoint at which the policy band is centred
- Adjust the width of the policy band
#1 Adjust The Slope Or Rate Of Appreciation For The S$NEER
The most frequently used adjustment is the adjustment of the slope or rate of appreciation of the S$NEER. This is also known as the crawl rate. When the slope is positive, the Singapore dollar is allowed to appreciate. The greater the increase of the slope, the faster the Singapore dollar is allowed to appreciate. A positive slope is equivalent to a tightening of monetary policy for MAS as it helps to contain inflationary pressures.
On the flip side, the 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$NEER policy band was reduced in January and October 2015 before reaching 0% in April 2016. This was in response to softening growth and inflation outlook.
While the MAS can theoretically set the slope to negative, it has never done so as a negative slope could trigger entrenched market expectations of a weaker Singapore dollar and induce a self-reinforcing sell-off, leading financial and macroeconomic instability.
Instead, the MAS has 2 other adjustments it can make to the S$NEER.
#2 Adjust The Midpoint At Which The Policy Band Is Centred
In times of poor economic outlook such as if inflation and growth fell sharply and a prolonged period of low or negative inflation was expected, MAS could recentre the policy band lower.
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 was projected to continue falling. This re-centring move in April 2009 was done after the slope of the policy band has already been reduced and flattened in October 2008.
For April 2022, the MAS has re-centred the mid-point of the policy band and increased the slope. This is a tightening of monetary policy to moderate the effects of inflation on Singapore’s economy. As the inflationary pressures are expected to continue for the medium-term, we can see that MAS has utilised the re-centring of the policy band on top of adjusting the slope. However, the width of the policy band remains unchanged
#3 Adjust The Width Of The Policy Band For S$NEER
The final tool in MAS’ arsenal is the adjustment to the width of the policy band.
In the times when there are significant levels of uncertainty in economic outlook and inflation and MAS expects this uncertainty to persist, the policy band may be widened. A wider policy band allows more room for market-determined movements in the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) during the period of uncertainty.
This was last done in October 2001 after the terrorist attacks in the United States.
MAS Implements The Management Of S$NEER Through The Forex Market
In order to actually implement the policy changes of the S$NEER, the MAS may intervene directly in the spot foreign exchange (forex) market.
These forex intervention operations involve the sale or purchase of US$ against the S$ to ensure that the S$NEER is kept within the policy band and is consistent with domestic price stability. S$-US$ intervention is the preferred operation since this is by far the most liquid S$ currency pair traded.
In practice, there is usually no need to conduct significant intervention operations to implement the monetary policy stance after the policy announcement as the market would respond in accordance.
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