Monetary Policy in East Asia:
The Case of Singapore
Keynote Speech by Bennett T. McCallum

The Monetary Authority of Singapore conducts policy by adjusting theSingapore dollar’s effective exchange rate so as to achieve macroeconomic
goals for the economy’s inflation rate and output gap. Estimates of a policy
rule of the Taylor type, except with exchange rate appreciation serving as the
instrument/indicator variable, substantiate this interpretation. That thisrule reflects policy that is much like inflation targeting is evidenced by theabsence of any significant role for the real exchange rate as a distinct target
variable in addition to inflation and the output gap. Simulations with adynamic model of a small open economy illustrate that this type of rule canbe relatively more advantageous in economies that (like Singapore) are
extremely open to international trade. The analysis illustrates that monetary
policy and exchange rate policy are two sides of the same coin, which suggeststhat assignment of exchange rate management to a nation’s fiscal authority
is an anachronism.
Keywords: Exchange rate; Inflation targeting; Instrument variable;
Target variable; Open economy; Monetary policy
JEL Classification: E42, E58, F31, F41

Carnegie Mellon University (E-mail: bmccallum@cmu.edu)
I am grateful to Stefan Gerlach, Petra Gerlach-Kristen, Marvin Goodfriend, John Taylor, and Lin
Tian for various contributions.
MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007
DO NOT REPRINT OR REPRODUCE WITHOUT PERMISSION.

13

I. Introduction
A wide variety of monetary policy arrangements exists among the countries of East
Asia, ranging from the currency board system of Hong Kong and the constantly
discussed regime in China to official inflation targeting in South Korea, Thailand,
the Philippines, and elsewhere. One case that should be of particular interest is that ofSingapore. Of course, Singapore is a very small country—just a medium-large city—
yet it has a greater population and a larger GDP in U.S. dollar terms than those of
New Zealand, whose central bank has been notable as a leader in the worldwide surge
toward inflation targeting.1 More importantly, however, Singapore’s monetary policy
system is unique, fundamentally interesting, and not widely understood. There are a
few papers in existence that discuss the system, including items by Devereux (2003),
Gerlach and Gerlach-Kristen (2006), Khor, Robinson, and Lee (2004), McCallum(2006), McCauley (2001), Moreno (1988), Parrado (2004), Rajan and Siregar (2002),
Tian (2006), and Williamson (1998, 1999), plus several by the Monetary Authority ofSingapore (MAS). These reflect important differences in interpretation, however, overthe system’s essential nature. Accordingly, I propose to discuss aspects of the Singapore
system in the present paper, drawing heavily upon McCallum (2006).

II. Nature of the Singapore Monetary System
Let us begin with an informal description of the Singapore system, before turning
to a presentation in terms of an analytical model. A useful quote from a one-page
summary by the MAS itself is as follows:
Since 1981, monetary policy in Singapore has been centered on the management of the exchange rate. The primary objective has been to promote pricestability as a sound basis for sustainable economic growth. The exchange rate
represents an ideal intermediate target of monetary policy in the context of thesmall and open Singapore economy. . . .First, the Singapore dollar is managed
against a basket of currencies of our major trading partners and competitors . . . .
Second, MAS operates a managed float regime . . . .The trade-weighted exchange
rate is allowed to fluctuate within a policy band, the level and direction of which
is announced semi-annually to the market . . . . Third, the exchange rate policy
band is periodically reviewed to ensure that it remains consistent with theunderlying fundamentals of the economy.2
A careful reading of the foregoing, plus additional descriptions by MAS officials,
reveals a crucial aspect of this procedure. It is that the band, within which theSingapore dollar effective exchange rate is kept, is not at all constant through time.
Instead, the band may move upward or downward automatically as time passes
1. International Financial Statistics figures for 2005 are 4.33 million people and US$115 billion for Singapore ascompared with 4.03 million people and US$98.7 billion for New Zealand.
2. Monetary Authority of Singapore (n.d.).

14 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore(to allow for expected ongoing appreciation or depreciation) and, more importantly,
both the level and slope of the band—and even its width—may be discretely adjusted
each decision period.3 Crucially, these adjustments are made in a manner that isdesigned to keep inflation low—that is, to promote price stability. Some adjustmentsof the band may, in addition, be made in response to prevailing (or forecasted)behavior of real variables such as aggregate output or employment. Thus, the type of
exchange rate management employed by the MAS is very different from a traditional
fixed exchange rate. In fact, it would appear that the MAS operates with policy objectives quite similar to those of the Federal Reserve or the European Central Bank
(ECB) or the Bank of England: to maintain low inflation as a priority, with someattention also paid to output and/or employment considerations. Indeed, the MAS
system might even be regarded as basically a variant of inflation targeting, not a fixedexchange rate system!
To continue in this vein, the MAS procedures seem very much like those of
inflation-targeting central banks except that the MAS policy management involves
periodic adjustments in the exchange rate, rather than a short-term nominal interest
rate.4 The reason for this difference in policy behavior is, moreover, quite straightforward and simple: the Singapore economy is much more open to foreign trade thanthose of, for example, the United States, Japan, the euro area, or the United
Kingdom. Instead of an export/GDP ratio of about 0.15 (or about 0.25 for theUnited Kingdom), for Singapore the value is currently about 1.4–1.5! Thus theexchange rate channel of monetary policy transmission is much more important,relative to the familiar interest rate channel, than in larger economies that are lessopen to international trade. Accordingly, use of the exchange rate, rather than ashort-term interest rate, as the principal instrument/indicator variable for monetary
policy may provide a relatively more effective way of managing aggregate demand.5
This policy comparison will be analytically illustrated below.
The foregoing suggestion that the MAS policy framework is basically one in whichinflation is the main target variable, with the exchange rate being used primarily as
an instrument or indicator for specifying policy actions that are designed to keep
inflation close to target, is supported by the behavior of the exchange rate over theyears 1981–2005. The period discussed begins with 1981, because that is the year inwhich the current MAS policy regime was put in place, according to MAS (undated,2001). The statistics indicate that, over the span from 1981 to the middle of 1997, theSingapore dollar appreciated in value by about 45 percent relative to the policy basket,
despite a large drop in 1985–87. This appreciation was needed to prevent inflation,
since (1) foreign inflation was proceeding at a rate higher than the Singapore target
and also (2) because rapid productivity growth in Singapore was bringing about
3. The MAS often refers to the “BBC” aspects of its procedure, these letters referring to “band, basket, and crawl.”
That terminology, which draws upon Williamson (1999, 2001), will be discussed further in Section III.
4. As will be seen below, the MAS system includes practices that do not reflect policy transparency of the degree
usually attributed to inflation-targeting central banks.
5. One should not infer, however, that adjustments in the exchange rate are necessarily implemented by open market
purchases in the foreign exchange market. Except when interest rates are at (or near) zero, such adjustments
could alternatively be implemented by purchases in the domestic money market. Throughout, I presume thatpurchases or sales in the foreign exchange market are not sterilized. If a policy action concerning the exchange rateis undertaken for the purpose of affecting aggregate demand, it makes no sense at all to use sterilized interventions.

15

an ongoing appreciation in real terms, due perhaps to the Balassa-Samuelson effect.
After a fall during the Asian financial crisis of 1997–98, the value of the Singapore
dollar leveled off and has not changed much since. Even so, its value remained about
35 percent higher in 2005 than in 1981 in terms of the (trade-weighted) basket.
More formal evidence in this regard requires a more analytical description ofpolicy behavior. The most common formulaic representation of monetary policy
procedures for more typical economies is provided by some variant of the “Taylor rule,”
introduced by Taylor (1993), which relates periodic adjustments in a money market
interest rate made in response to existing (or predicted) inflation and output gap
measures. A standard formulation is
R t = r + pt + 1(pt −  *) +  2(yt − y–t ) + t ,

1,  2 ≥ 0,

(1)

where R t is the interest rate, pt is the current inflation rate,  * is the target inflation
rate (at which the central bank wishes to keep inflation on average), and yt − y–t is theoutput gap, in other words, the percent (or fraction) by which real output exceeds the“natural rate” of output that represents an efficient, market-clearing level. The term
t represents random policy influences by the central bank, which in principle shouldbe very small.
In comparison to (1), the Singapore policy rule might be represented as follows:et = e − pt + 1(pt −  *) +  2(yt − y–t ) + t ,

1,  2 ≥ 0.

(1′)

Here et is the log of the nominal exchange rate, expressed as foreign currency units
per unit of home-country money (e.g., yen/U.S. dollar if the United States is taken as
the home country). Correspondingly, e is the average rate of appreciation of thecurrency (perhaps negative) that reflects the sum of the long-run rate of appreciationof the real exchange rate plus the average inflation rate abroad. Clearly, monetary
policy designed to reduce inflation when it is above its target value would call for an
increase in et under this rule, rather than an increase in R t . This desired increase
could in principle be brought about by the central bank by conducting open-market
sales of foreign exchange, although in normal circumstances it could alternatively beeffected by the sale of short-term domestic securities, as would usually be the casewith the Taylor rule (1).6 It should be emphasized that the policy behavior describedby (1′) is not intended to keep the exchange rate at any particular value other thanwhatever would be consistent with the inflation and output gap targets specified on
the right-hand side of the relationship.
Is there any reason to believe that in reality MAS behaves in a manner similar torule (1′)? In that regard, MAS Staff Paper No. 31, 2004, written by Eric Parrado,then of the International Monetary Fund (IMF), uses monthly data for 1991–2002
to estimate a rule of the form (1′) but with inclusion of an additional et −1 term toreflect smoothing of the exchange rate. (Also, his preferred equation uses the expected
6. If foreign exchange and domestic short-term securities were perfect substitutes, then a purchase (of a given size)of either would have the same effect. This paper’s analysis presumes that these two assets are close but not
perfect substitutes.

16 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore

inflation rate nine months into the future, rather than the current rate.) Parrado’s(2004) instrumental variable estimates are as follows:7
et = −0.006 + 1.89Et −1pt +9 + 0.42(yt − y–t ) + 0.85et −1.
(0.009) (0.55)(0.14)(0.022)R 2 = 0.86

(2)J-stat p -value = 0.85

Clearly, these estimates provide considerable support for the suggestion made above.
It must be said that the MAS normally does not describe its policy in this manner,instead emphasizing the “BBC” (band, basket, and crawl) aspects of exchange rate
policy that have been promoted in the work of Williamson (1999)—see Khor,
Robinson, and Lee (2004). But if the band and its crawl are designed primarily toachieve targets for pt and yt − y–t , then this amounts basically to the same thing as
inflation targeting, as is argued above.

III. Empirical Evidence
While the arguments and evidence presented in the previous section are highlysuggestive, a more direct test of our proposition—that the Singapore system is much
like a variant of inflation targeting—would clearly be useful. Such a test should
be based on aspects of inflation targeting that differ from those of the approachof Williamson (1999, 2001, 2006) to policy management, as the latter has beenprominent in the MAS literature. I would argue that the most important operational
difference between the two is that inflation targeting presumes there will be no responseof policy to exchange rate movements (or departures from target values) beyond thosecalled for by inflation and output gaps relative to target. That characteristic is impliedby the Taylor-style formulation (1′) above. By contrast, Williamson’s writings, which
explicitly advertise their distinction from inflation targeting, call for an international
system based on “reference rates” that are basically targets for each economy’s realexchange rate. A quote from Williamson (2006, pp. 7–8) may be helpful.
The concept of a reference rate was introduced many years ago by Ethier andBloomfield (1975). They thought of a reference rate as an officially agreed
exchange rate that would carry with it an obligation not to intervene . . . in a
way that would tend to push the market exchange rate away from the reference
rate. Countries would be allowed to intervene, but only in an internationallysanctioned way—to push the rate toward the reference rate . . . Ethier andBloomfield did not address exactly what concept of the exchange rate was . . .
[relevant], but clearly it is what matters for the macroeconomy: the real effective
exchange rate.
7. Here the figures in parentheses are standard errors, the R 2 statistic is unadjusted, and the reported p-value is for
Hansen’s J-statistic for testing the hypothesis that the assumed orthogonality conditions are valid.

17

Our strategy will be to estimate a policy equation, analogous to that in Parrado(2004), to demonstrate independently that the Singapore exchange rate movements
are consistent with a policy of the type expressed in equation (1′), and then to add
additional variables, designed to reflect departures of the real effective exchange ratefrom some target value, to see if these have any additional explanatory power beyond
that provided by the inflation and output gap variables in (1′).8 Accordingly, we begin
with estimation of an equation similar to that of Parrado (2004), but using quarterly—
rather than monthly—observations. Also, following Gerlach and Gerlach-Kristen(2006), I use a four-quarter average inflation rate pta instead of Parrado’s inflation rate
for nine months into the future. The sample period is 1981/Q1–2005/Q4, the startdate being that of the regime’s inception and the end date omitting recent observations
that might be subject to revision. The data series are mostly taken from the IMF’s
International Financial Statistics; details are reported in the Data Appendix at the endof the paper. Least squares estimates are 9
et = −0.0025 + 0.3245pta + 0.174(yt − y–t ) + 0.0735et −1.
(0.0017) (0.0765)(0.0494)(0.0988)
R 2 = 0.379

SE = 0.01274

DW = 2.05(3)

T = 100

Here the results are reasonably similar to those of Parrado (2004), with inflation entering strongly and the output gap significantly. One major difference is that in (3) the
lagged dependent variable provides almost no explanatory power, whereas in Parrado(2004) it is quite important. This difference is presumably attributable to the use hereof quarterly data series, Parrado’s being monthly. Our R 2 value is considerably lower,
but that is not of importance since our parameters’ standard errors are of the sameorder of magnitude.10
In considering the specification of (3), one reaction is to doubt the availability ofdata on inflation and the output gap for quarter t to the central bank when setting
the Singapore dollar exchange rate for that quarter. More sensible would be to believethat the MAS policymakers have at their disposal only values of those variables forprevious periods. Accordingly, equation (3) should be re-estimated by instrumental
variables, using as instruments the constant term and once-lagged values of the otherright-hand-side variables (if not already lagged). The resulting estimates are as follows:et = −0.0025 + 0.3256pta + 0.220(yt − y–t ) + 0.0385et −1.
(0.0019) (0.0895)(0.0647)(0.108)R 2 = 0.372

SE = 0.01284

DW = 1.997(4)

T = 99These results are qualitatively similar to those in (3).
8. This approach is used by Tian (2006).
9. In (3) and in subsequent equations, SE denotes the estimated standard deviation of the disturbance term, DW isthe Durbin-Watson statistic, and T is the number of observations.
10. Evidently Parrado’s exchange rate data, which are not described, feature much more variability because of theirmonthly frequency. Since the variables are changes, this seems entirely plausible.

18 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore

At this point we wish to test whether the real exchange rate, or its deviation froma target value, provides independent explanatory power. As a start, we include the logof the real exchange rate from the previous period as an additional regressor; the idea
being that if this variable (lreer ) is “high,” then it will exert a downward influence on
the change in the nominal rate—its coefficient will be negative. Since the variable islagged, it serves as its own instrument. Instrumental variable estimates are as follows:et = 0.1350 + 0.3435pta + 0.2475(yt − y–t ) + 0.0335et −1 − 0.0300lreert −1.
(0.0777) (0.0882)(0.0647)(0.107)(0.0169)(5)
R 2 = 0.383

SE = 0.01279

DW = 1.994

T = 99In this case, the real exchange rate variable provides only marginally significant incremental explanatory power. Simply adding the (log) variable in this way amounts,
however, to treating its target value as constant over the entire sample period. As that
implication seems implausible, we next try entering (in the same way) the variable’s
departure from a fitted linear trend:et = −0.0027 + 0.3368pta + 0.2473(yt − y–t ) + 0.0352et −1(0.0019) (0.0885)(0.0648)(0.107)− 0.0290lreerresidt −1.
(0.0170)
R 2 = 0.382

SE = 0.01280(6)
DW = 1.994

T = 99Again the incremental explanatory power is barely significant, and experimentation withhigher polynomials in time yields results even more unfriendly to the tested hypothesis.
Again, however, the implied “equilibrium” real rate is represented in a rather unsatisfactory manner. More ambitiously, one might attempt to construct a model of the target
rate—but that would be both problematic and beyond the scope of this study. A feasible
representation of the target rate can be constructed, however, by means of the popular
Hodrick-Prescott filter, with the departure of actual from “trend” used as the variable toenter into the estimated policy rule. Indeed, this procedure seems rather consistent with
Williamson’s (2006) characterization of his reference value. Accordingly, we now enter
the Hodrick-Prescott “cycle” component as the real exchange rate variable:
et = −0.0025 + 0.3174pta + 0.2666(yt − y–t ) + 0.0472et −1(0.0018) (0.0886)(0.0613)(0.1067)− 0.0972lreerhpct −1.
(0.0378)
R 2 = 0.4006

SE = 0.01261(7)
DW = 1.971

T = 9919

In this case, the estimated coefficient on the real rate variable is 2.56 times its standard
error, thereby being of greater than marginal significance. So in this case, there issome appreciable evidence of a separate role for the real exchange rate, even though its
contribution to the adjustment of the policy variable, et , is considerably less than thatof either the inflation or output gap variables.11
Before drawing that conclusion, however, one should consider the possibility that thenature of the MAS policy practice has evolved over the 25 years since its inception. Indeed,
it would seem highly unlikely that significant changes have not occurred, especially as thedevelopment of inflation targeting as a practical policy system began only around 1990! As
a matter of local concern, the 1985 recession in Singapore was rather severe and a major
exchange rate adjustment took place during the first two quarters of 1986. Accordingly, I
have applied the Chow parameter stability test to equation (7) for two breakpoints, 1987/
Q1 and 1989/Q1. The p-values for these tests are 0.0079 and 0.0399, clearly indicating
the presence of a break. Then re-estimating (7) with a start date of 1990/Q1, we obtain
et = −0.0040 + 0.5304pta + 0.1735(yt − y–t ) − 0.104et −1(0.0023) (0.1396)(0.0782)(0.146)− 0.0121lreerhpct −1.
(0.0957)
R 2 = 0.2937

SE = 0.01086(7′)
DW = 2.027

T = 64In this case, the role of the real exchange rate variable is not even slightly significant,whereas the inflation variable continues to be highly important. Chow stability tests
for this sample period do not indicate breaks at any of the following dates: 1995/Q1,
1997/Q1, 1999/Q1, and 2001/Q1.
In sum, the results of the foregoing investigation provide substantial support for
the hypothesis that Singapore’s monetary policy has not, since 1990, given the realexchange rate a role as an independent objective, in addition to the objectives ofstabilizing inflation and output around their desired levels. The MAS policy, that is,has since 1990 been more of an inflation-targeting regime than one of the BBC typepromoted by Williamson (1999, 2001, 2006).12

IV. Analysis with Open-Economy Model
Let us now illustrate how any of the foregoing monetary policy rules—or others—
could be utilized in combination with a formal quantitative model, of a small economy
open to foreign trade, for the purpose of monetary policy analysis. One particular
example of such a model is the one utilized by McCallum and Nelson (1999) and11. The incremental contributions of the different regressors are monotonically related to the relevant t -ratios—see, for example, Goldberger (1964).
12. In other words, the results constitute positive analysis indicating that Singapore has conducted policy in a mannerconsistent with that suggested from a normative point of view by Taylor (2001, pp. 264–266).

20 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore

McCallum (2005). This model differs from a more standard optimizing specification(e.g., Clarida, Gali, and Gertler [2002]) by treating imports as raw materials for the
production process rather than as finished consumer goods, but in both cases the basicrole of the (real) exchange rate is to induce substitution away from usage of foreignproduced goods when they are relatively expensive. It is a small open-economy modelthat can be summarized by means of the following equations:ct = Etct +1 + b 0 − b 1rt + vt ,(8)

yt = 1ct +  2g t +  3 x t ,(9)imt = yt − qt + const,(10)

qt = st − pt + p*t ,(11)xt = y *t +  *qt + const,(12)

y–t = (1 − 2)−1[1at − 2qt ] + const,(13)

pt = (1 + )−1[ Et pt +1 + pt −1] + (yt − y–t ) + ut ,(14)

R t − R *t = Et st +1 + t ,(15)

rt = R t − Et pt +1.

(16)

A very brief description of each will be provided. Equation (8) is a consumption (ct )Euler equation, reflecting intertemporal optimization, while (9) is a log-linearized
approximation to an identity that splits output yt —not value added!—into threecomponents: consumption, government consumption g t , and exports xt .13 Next, in(10) import demand imt is given by cost minimization for a production function of
the CES type with  as the elasticity of substitution between imports and labor.
An analogous relation (12) governs demand from abroad for home-country exports.
Equation (11) defines the log of the real exchange rate qt in relation to the log of thenominal exchange rate st (st = −et ) and the logs of home and foreign price levels, pt
and p*t . Equation (13) specifies the natural rate (i.e., flexible-price) value of the log ofreal output, y–t , with this value depending upon a stochastic term at that reflects theresults of technology shocks (assumed to follow an exogenous AR(1) process with
autocorrelation parameter 0.95) and the real price of imported inputs to production.
A variant of the Calvo model of nominal price stickiness appears as (14), while (15)represents uncovered interest rate parity, with a stochastic disturbance.14 Finally, (16)is the Fisher identity that defines the one-period real rate of interest rt in relation to
the nominal rate R t and expected inflation.
13. Domestic investment would also be included in a model that distinguishes between consumption and investment
spending. The variables ct , gt , xt , and im t (as well as yt , pt , st , and qt ) are in logarithms.
14. This disturbance incorporates our assumption that foreign and domestic securities are not perfect substitutes.

21

Together with the Taylor-type policy rule (1), this model provides 10 structural
equations to generate values of the system’s 10 endogenous variables, namely, c, y, g,
x, im, p, s, q, R, and r. Thus, we can very simply establish the main point of thissection, which is that adoption of the st policy rule (1′) would not alter the lists ofendogenous and exogenous variables. Consequently, it follows that use of st as thepolicy-rule instrument, rather than the more standard R t , is perfectly sensible andcoherent. Which of the two instrument/indicator variables would be more desirable
will be determined by quantitative aspects of the economy under consideration.
To make such a determination for the model given above, quantitative values haveto be assigned to each of the model’s parameters, including those that describe thestochastic behavior of the exogenous variables and shocks that impinge upon thesystem. In McCallum (2005), I have calibrated the model (8)–(16) to represent a“typical” industrial economy, setting the average ratio of imports (and exports) to
production (not value added) at 0.15.15 For Singapore, the comparable figure isapproximately 0.6.16 It will be of interest to compare the performance of policy rules(1) and (1′), with 1 =  2 = 0.5 and smoothing of the policy variable ( 3 = 0.8)
added in each case, under these (and other) specifications of the economy’s degree of
openness, with the other aspects of the calibration kept the same.
The relevant comparison is provided in Table 1. There X /Y denotes the ratio of theeconomy’s exports (and imports) to production, which is varied over a wide range inthe different columns. For a given calibration of the model, described in McCallum(2005), the two rows of cells report the variability of inflation, the output gap, theinterest rate, and the exchange rate’s rate of appreciation. With all variables measured
as percentage deviations from steady-state values, quarterly but in annualized units, thefigures for inflation and the output gap represent root-mean-square deviations fromtarget. Accordingly, small values are more desirable than large values.
Going across the top row, we see that with an interest rate instrument rule, poorer
performance is realized with highly open economies. Moving from X /Y of 0.15 to 0.60,
to be specific, results in approximately no change in inflation variability but a major
increase in output gap variability. Effects on the variability of interest and appreciation
rates are minor. In the second cell row, by comparison, the exchange rate rule isTable 1 Effects of Openness on Policy Rule Performance

Rt rule (1)st rule (1′)

X/Y = 0.01
2.72
2.11
2.96
19.36
4.27
2.76
9.37
1.83

X/Y = 0.15
2.34
1.95
2.45
18.46
3.61
2.41
9.28
1.65

X/Y = 0.30
2.22
2.37
2.30
17.75
3.25
2.21
9.29
1.56

X/Y = 0.60
2.30
4.81
2.42
16.01
2.62
2.20
9.26
1.44

Note: Cell entries are standard deviations of pt , y–t , Rt , and st .
15. The model used also includes a feature representing habit formation in consumption behavior.
16. Singapore’s exports (X ) and imports (M ) are each about 1.5 times as large as GDP, implying a value of 0.6 forM /Y. To see this, note that GDP = Y − M, so Y /M = 1 +GDP /M.

22 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore

increasingly effective in stabilizing inflation and output as the degree of openness isincreased. Thus, for the model at hand, it is clearly the case that an increased degreeof openness makes use of the exchange rate rule relatively more attractive.
Does the very high level of openness reflected by X/Y = 0.6 also make rule (1′) more
attractive in absolute terms? From the last column of Table 1, we see that in that casevariability of inflation is (slightly) increased but variability of the output gap is (greatly)
reduced by use of the exchange rate rule (relative to the case with use of the interest raterule). The answer will then depend upon the weight assigned by the relevant objectivefunction to output gap variability relative to inflation variability.17 If the value were
0.1 for the latter relative to inflation variability (in terms of variances), then theexchange rate rule (1′) would be preferable. Weights somewhat lower than 0.1 are
not uncommon in the literature, however, so the absolute superiority of (1′) is not aforegone conclusion. Also, it is possible that the variability of R t and st or st would
be taken into account by the relevant central bank. Accordingly, no conclusion of
the absolute type can be made on the basis of our simple study.18 For this type ofcomparison, a more precise numerical calibration of the model and a more carefulconsideration of the appropriate objective function would have to be developed. These
are tasks that are beyond the scope of this paper.

V. Conclusions
The past three sections have developed a characterization of Singapore’s monetary
policy—as featuring periodic adjustments of the exchange rate, used as an instrument/
indicator variable, designed to achieve objectives involving inflation and output—
and have illustrated analytically this type of policy’s relative effectiveness for economies
with very high ratios of trade to domestic production. In light of Singapore’s
macroeconomic success over the past 15 years, as discussed by various writers
including Devereux (2003), Gerlach and Gerlach-Kristen (2006), McCauley(2001), Parrado (2004), and Rajan and Siregar (2002), it seems apparent that thistype of policy regime could be an attractive contender for adoption by other highly
open economies.
A more general conclusion can be drawn, however, one that is applicable also to
economies which are not of the small and extremely open type and do not conduct
policy via an exchange rate instrument. It concerns the relationship between“monetary policy” and “exchange rate policy.” The main point, which should beapparent from the policy exercises of Section IV, is that basically these are not two
different aspects of macroeconomic policy but, instead, two ways of thinking about
one macroeconomic policy tool. That is, a nation’s monetary authority can use as its
instrument/indicator variable only one chosen nominal variable—a nominal interest
rate, a nominal exchange rate, or some accurately controllable monetary aggregate
17. If X /Y were assumed to be 0.75, however, the exchange rate rule would result in inflation and output standard
deviations of 2.08 and 2.15, both smaller than the values 2.56 and 7.11 provided by the interest rate rule.
18. It is also the case that the two rules utilize “realistic” parameters, not ones optimized in terms of the model andsome specific objective function.

23

(e.g., the monetary base). Its policy is then described by a rule for adjusting, upward
or downward, this nominal variable in response to important measures of the current
macroeconomic situation. It will make such adjustments in an attempt to keep
chosen target variables, possibly including real variables such as employment or the
output gap but necessarily including some nominal variable, close to desired target
values. But in a market economy substantially free from distorting controls, there canbe only one such rule. In essence, then, monetary and exchange rate rules are merely
two aspects of one policy—most usefully thought of as monetary policy. Analytically,
this can be illustrated as follows. If one included both equations (1) and (1′) with themodel in (2)–(10), the system would be overdetermined. Thus there could be, except
by chance, no solution for the 10 endogenous variables.19
In light of these observations, the widespread practice of official assignment of(nominal) exchange rate responsibility to a nation’s fiscal authority—in other words,
its Finance Ministry or Treasury—should be recognized as unfortunate and undesirable. Such an assignment, pertaining to a monetary variable, is inconsistent in spirit
with the raison-d’être of central bank independence and can potentially interfere
drastically with the conduct of monetary policy. Legal arrangements of this type arein fact present in numerous economies including the United States, the European
Union, and Japan.20 For some of these, such as the European Union, the potential
undesirability under discussion has not been highly disruptive in practice in recent
years, because the fiscal authorities have not attempted to bring about an exchange
rate path for their economy that is inconsistent with the price level path implied by
the central bank’s monetary policy.21 Some economists, however, would argue thatexchange rate legalisms in Japan contributed significantly to its poor macroeconomic
performance over the decade 1993–2003.22,23 More drastically, the current situation in
China illustrates quite clearly that major difficulties for monetary policy can bebrought about by exchange rate paths which are inconsistent with appropriate anddesired monetary policy. In any event, the assignment of exchange rate responsibility
to a nation’s fiscal authority is an anachronism, left over from the pre-1973 era when
exchange rates, not central bank policy rules, provided nations’ nominal anchors.24
The practice is bound to cause confusion, if not actual mismanagement.

19. This does not imply that a single monetary policy rule cannot respond (with specified weights) to two or morenominal variables or that more than one nominal variable cannot appear in the central bank’s objective function.
20. This is well known in the case of Japan and the European Central Bank; for the United States, see the discussionof Broaddus and Goodfriend (1996).
21. Our argument does not imply that fiscal authorities should not have responsibility for real fiscal magnitudes, suchas the real fiscal deficit or even possibly the real trade balance, which may be structurally related to real exchange
rates. Management of nominal exchange rates will have only temporary effects on these real magnitudes, of course.
22. Economists including Svensson (2001) and McCallum (2000) have argued that effective monetary stimulus tocombat the Japanese deflation of 1995–2003 could have been provided by central bank purchases of foreignexchange, and some members of the Bank of Japan staff believed that such a strategy deserved consideration,
given the apparent (and theoretical) inability of the Bank of Japan to affect spending by purchase of short-term
domestic securities. It was decided, however, that foreign exchange operations could only be made at the directionof the Ministry of Finance. For additional discussion, see McCallum (2003, pp. 22–27).
23. Some would also argue that Japanese exchange rate management by the Ministry of Finance during the late1980s, based to some extent on urgings of the U.S. government, contributed strongly to the asset price bubble
that in turn led to the tightening of Japanese monetary policy in 1989 which began the deflation.
24. The anachronistic nature of this assignment comes through strongly in Broaddus and Goodfriend (1996).

24 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore

DATA APPENDIX
Observations
1980/Q1
Q2
Q3
Q4
1981/Q1
Q2
Q3
Q4
1982/Q1
Q2
Q3
Q4
1983/Q1
Q2
Q3
Q4
1984/Q1
Q2
Q3
Q4
1985/Q1
Q2
Q3
Q41986/Q1
Q2
Q3
Q4
1987/Q1
Q2
Q3
Q4
1988/Q1
Q2
Q3
Q4
1989/Q1
Q2
Q3
Q4
1990/Q1
Q2
Q3
Q41991/Q1
Q2
Q3
Q41992/Q1
Q2
Q3
Q4
1993/Q1
Q2
Q3
Q4

NEER
71.81000
71.06000
71.12300
72.02300
73.22000
75.14000
77.9000078.98000
80.14300
80.98000
82.27700
82.07300
83.70000
84.51700
84.94300
84.71300
85.28000
86.11000
87.29300
88.72000
89.14300
88.09300
85.72700
84.76300
80.55700
75.52300
74.88300
75.14000
74.07000
72.29300
73.71300
72.73700
72.71000
72.55000
74.27000
74.50000
77.05700
78.65700
78.91700
79.21700
80.92300
82.40300
82.97300
83.55300
83.71700
85.41700
87.50000
88.04700
89.00300
89.15300
88.26000
89.68700
90.22000
89.61700
90.38300
92.41000

REER
98.59700
96.32330
95.44300
95.54700
96.35300
100.43700
105.03300
106.19300
107.63700
106.57000
106.83300
106.59700
108.32700
108.45300
108.02000
107.72000
109.09300
109.45700
110.40300
110.80700
110.90700
109.00000
105.54000
103.40300
97.13700
90.42300
88.95700
89.04000
87.25000
84.80000
86.26700
84.80000
84.55700
83.85300
85.21700
84.71670
86.90300
88.52000
88.75000
89.11000
93.15000
94.32700
94.45000
95.18700
95.60700
97.43000
99.28000
99.35700
100.08300
99.96700
98.87000
100.27300
100.55700
99.45000
100.10300
102.38000

CPI
66.00700
66.94400
68.12400
68.69800
69.69600
72.11500
74.62500
75.41100
76.16700
75.29000
75.65300
76.16700
76.53000
76.37800
76.65000
77.34600
78.82800
78.55500
78.97900
78.52500
79.00900
79.00900
79.40200
78.97900
78.58600
77.76900
77.73900
77.92000
77.95100
78.10200
78.70700
78.88800
79.1900079.28100
79.91600
80.03700
80.18800
81.18600
81.91200
82.60700
83.30300
83.81700
84.39100
85.66100
86.35700
87.05200
87.41500
87.89900
88.29200
89.01700
89.44100
89.86400
90.46900
90.92200
91.37600
92.01100GDPRSG
8,966.000
9,317.000
9,648.000
10,028.000
9,790.000
10,268.000
10,628.000
10,967.000
10,682.000
11,015.000
11,311.000
11,614.000
11,471.000
11,883.000
12,292.000
12,777.000
12,712.000
13,009.000
13,306.000
13,431.000
13,084.800
12,890.500
12,904.200
12,822.500
12,625.900
13,019.600
13,388.200
13,775.300
13,571.100
14,165.100
14,821.500
15,390.500
15,055.600
15,909.200
16,583.600
16,954.500
16,513.200
17,785.200
18,149.600
18,451.400
18,642.200
19,058.100
19,657.900
19,940.700
19,840.700
20,285.900
21,108.400
21,289.500
20,921.100
21,452.200
22,532.900
23,140.900
22,880.900
24,269.600
25,286.600
26,401.100(Continued on next page)25

DATA APPENDIX (continued)
Observations
1994/Q1
Q2
Q3
Q4
1995/Q1
Q2
Q3
Q4
1996/Q1
Q2
Q3
Q4
1997/Q1
Q2
Q3
Q4
1998/Q1
Q2
Q3
Q4
1999/Q1
Q2
Q3
Q4
2000/Q1
Q2
Q3
Q4
2001/Q1
Q2
Q3
Q4
2002/Q1
Q2
Q3
Q4
2003/Q1
Q2
Q3
Q4
2004/Q1
Q2
Q3
Q4
2005/Q1
Q2
Q3
Q4

NEER
93.02300
93.90000
94.25000
95.90000
96.68300
95.63700
97.15000
98.82700
100.37700
101.23300
101.12000
102.36700
103.88300
103.44000
103.09700
102.62700
105.98300
107.44000
103.92300
102.63300
99.24300
99.70000
100.06000
99.66000
99.09700
99.17700
100.03000
101.69700
102.34000
101.29000
102.58700
100.27300
101.31700
100.58700
100.58000
100.71700
100.07300
98.44000
97.94300
96.94700
97.04700
98.04700
97.79000
98.58700
98.33000
98.25300
98.72300
99.48300

REER
102.92700
104.27000
104.45300
106.12300
106.28700
105.01000
106.03300
107.43000
108.65700
109.11700
108.50300
109.46000
111.03300
110.40000
110.01700
109.20300
110.62000
110.41300
105.59300
103.41000
99.92670
100.50000
100.59700
99.77330
99.37330
99.13670
99.96000
101.52300
101.90300
100.38700
101.18700
98.41670
98.72000
98.00000
97.47670
97.31000
96.24330
94.48000
93.87700
92.69670
92.99330
93.75330
93.05670
93.24330
92.18000
91.73670
91.85700
92.47300

CPI
92.79700
93.76500
94.49000
95.03400
95.12500
95.73000
95.79000
95.91100
96.36500
96.84900
97.15100
97.48400
98.02800
98.51200
99.35800
99.72100
99.15940
98.63200
98.50000
98.26900
98.43400
98.59900
98.79700
98.79700
99.52200
99.42300
100.28000
100.77500
101.20300
101.10400
101.10400
100.57700
100.34600
100.67600
100.67600
100.70900
101.03800
100.87400
101.17000
101.36800
102.30500
102.75100
103.09400
103.02500
102.54500
102.78500
103.57400
104.19000

GDPRSG
26,169.600
26,726.000
28,433.300
28,780.500
27,892.300
28,947.300
30,867.400
31,255.700
31,356.500
31,674.800
32,306.300
33,315.000
32,909.400
34,567.800
35,913.500
36,208.000
34,262.100
34,293.200
34,670.500
35,173.400
34,978.800
36,541.200
37,585.900
38,181.600
38,347.500
39,554.000
41,355.200
41,886.100
39,906.100
39,058.500
39,018.500
39,335.400
39,292.100
40,551.100
40,485.400
40,524.800
39,802.900
39,010.200
41,457.000
42,822.000
42,947.300
43,808.400
44,441.900
45,605.400
44,106.900
46,086.400
47,788.000
49,921.000

Note: NEER, REER, and CPI are taken from the IMF’s International Financial Statistics electronic
database. These are index values of Singapore’s nominal effective exchange rate, real effective
exchange rate, and the consumer price index, respectively. The other series, GDPRSG, is realGDP. The values for 1982/Q3–2004/Q3 were provided by Gerlach and Gerlach-Kristen (2006)(from the Bank for International Settlements database), with 2004/Q4–2005/Q4 values spliced
on from International Financial Statistics.

26 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/DECEMBER 2007

Monetary Policy in East Asia: The Case of Singapore
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27

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