Ravi Menon: Securing price stability as Singapore restructures
Speech by Mr Ravi Menon, Managing Director of the Monetary Authority of Singapore, at the
Asian Bureau of Financial and Economics Research (ABFER) Opening Gala Dinner,
Singapore, 21 May 2013.
* * *
Professor Bernard Yeung, Dean, NUS Business School, whose tireless efforts have brought
to fruition the Asian Bureau of Financial and Economics Research, distinguished guests,
ladies and gentlemen, good evening.
Interesting times again
Monetary policy has become interesting again.
The Great Moderation, beginning in the mid-1980s and spanning two decades, marked the
triumph of monetary policy over the scourge of inflation. The formula worked brilliantly -
independent central banks, with clear mandates to pursue price stability, and doing so with
consistency and credibility, ushered in an era of macroeconomic and financial stability
supporting steady economic growth and rising prosperity.
Then came 2008/2009 - unleashing a financial crisis of unmatched scale and impact, and a
global recession deeper than any seen since the Great Depression. We are still living in the
shadows of these two shocks, with the global economy stuck in a hesitant and uneven
recovery and financial market stresses resurfacing from time to time.
Monetary policy in the advanced economies has entered unchartered waters, in a valiant
effort to support economic growth, which was being weighed down by deleveraging. In the
emerging economies, central banks and governments have had to be equally nimble in their
policy responses, as they grapple with the spillover effects of these unconventional monetary
policies.
Singapore has not been spared the effects of these broader global developments. Our
exchange rate-centred monetary policy has been remarkably successful over the decades, in
securing price stability amidst rapid economic growth and an open trade and capital account.
Consumer price inflation has averaged 1.3% per annum during 1985-2005, one of the lowest
in the world.
Inflation surged briefly in 2008, moderated in the wake of the Global Financial Crisis, but
resumed an upward creep from 2010 onwards. Consumer price inflation averaged 4.2%
during 2010-2012, the longest period of sustained inflation above 4% in Singapore's history.
It is particularly challenging that the current bout of inflation is occurring against the backdrop
of a slowing economy, weighed down by weak external demand and a tight domestic labour
market. And in a world awash with liquidity searching for both yield and safety, Singapore
has been at the receiving end of such flows.
Tonight, I will set out MAS' policy approach to securing price and financial stability, in this
"new normal" of an economy restructuring amidst a global environment of slow growth and
easy money. In most respects, this approach builds on the existing framework for monetary
policy; but in other respects, it takes a more comprehensive view of macro stability and
signifies the need for policy innovation in dealing with new realities.
Let me begin by describing the external and domestic context within which MAS is currently
operating.
External context: surging liquidity, diverging leverage
First, the global backdrop.
Monetary policy in the advanced economies has been extraordinarily loose for a prolonged
period of time. It has been unconventional in three important regards.
• First, short-term interest rates are at or close to the zero bound - and have been so
for over four years now.
• Second, central banks are purchasing non-traditional assets in large quantities to
exert downward pressure on long-term interest rates. This has been going on for
close to five years now, with central bank balance sheets in the US and the UK, for
example, ballooning to more than three times their pre-crisis levels.
•
Third, central banks are providing "forward guidance", either in the form of
commitments not to raise interest rates until certain real economy thresholds are
met or plans to expand the monetary base until an inflation target is reached,
helping to extend expectations of easy monetary conditions.
The overall impact of these measures has been to reduce tail risks in the advanced
economies and prevent a sharp deceleration in growth. But they have been less successful
in restoring economic growth to pre-crisis trend rates, in the face of deleveraging pressures.
Debt-to-GDP ratios in the G3 economies must normalise at lower levels to restore
macroeconomic and financial stability. This necessitates a decline in consumption. Banks are
less willing to lend, and the private sector less willing to borrow. The relationship between
liquidity and credit appears to have broken down.
The wall of money created in the advanced economies has led to extremely low interest
rates globally. This, coupled with stronger economic conditions, has led the private
credit-toGDP ratio in Emerging Asia to rise from 97% in 2008 to 122% in 2012 - this is higher than
the level seen at the start of the Asian financial crisis.
In short, the advanced economies are develeraging, and the Asian economies are
releveraging. In and of itself, this is not a problem. In fact, the divergence in leverage is to be
expected in the context of global rebalancing, with advanced economies restraining
consumption and Asian economies boosting domestic demand.
But it is the pace and composition of Asian releveraging that is cause for concern. While
much of the rapid loan growth has supported productive economic activity, there have also
been substantial flows to asset markets, especially real estate. Low interest rates and
abundant liquidity have contributed to accelerations in property prices and sharp increases in
household debt.
•
Residential property prices in Taiwan, Hong Kong, and Singapore have increased
by 52% on average since 2009, while nominal wages have risen by only 13%.
•
Household debt as a percentage of GDP has trended up in these countries, with
mortgages accounting for a significant 70-80% of consumer credit.
Inflation in asset prices and build-up in leverage have important implications not just for
macroeconomic stability but also financial stability. I will come back to this later.
Domestic context: supply constraints and economic restructuring
Next, the domestic context.
The Singapore economy is facing a demographic double-whammy: the effects of low birth
rates over the last two decades combined with the entry into retirement of the baby boom
generation.
•
Singapore's total fertility rate has been very low, at about 1.4 over the last 20 years.
•
Baby boomers entering the "65 & above" age group, where significant numbers
retire and leave the workforce, will surge by 65% during 2011-2020.
The overall impact of this double-whammy is unmistakeable: Singapore's resident labour
force will start to shrink over the next few years, even after taking into account the inflow of
net migrants.
Singapore had previously supplemented its resident labour force with foreign workers. Total
labour force growth averaged 3.7% per annum in the last decade (2001-2010); almost half of
which was contributed by foreign workers. This is unsustainable. Foreigners (excluding
foreign domestic workers) already account for about one-third of the total labour force in
Singapore.
demographic
Singapore is heading towards a cliff. It cannot be avoided. The question is
whether the economy achieves a soft landing or a hard landing. If we restructure our
economy and raise our productivity, Singapore can grow at a slower but more sustainable
pace with a moderate increase in costs and prices. If we do not, costs will continue to
escalate, competitiveness will erode, and growth will dip sharply amidst higher inflation.
The transition to productivity-led growth will not be easy. As labour becomes more scarce, its
price will rise, prompting an adoption of labour-saving technologies or a shift of resources
into activities that utilise less labour. This increase in wage cost is a necessary part of the
restructuring process but will feed through more generally into prices, especially for a range
of domestic consumer services which had hitherto depended heavily on foreign labour, such
as cleaning, healthcare, cooked food, and hospitality. Inflation will be temporarily higher, as
productivity-enhancing measures take time to bear fruit.
During this transition, which will take a few years, the growth-inflation trade-off will worsen.
•
GDP growth will be slower during 2011-2020, at 3-5% per annum, about 2% points
lower than the average 6% growth in the last decade. This will mainly reflect a sharp
reduction in labour force growth.
• At the same time, inflation is expected to be around 1% point higher in this decade
compared to the last. MAS Core Inflation is likely to average 2.5% per annum, and
CPI-All Items inflation around 3%.
Managing inflation expectations and preventing inflation from escalating will be the key
challenge facing monetary policy during the transition to a productivity-based economy.
Macro policies for economic and financial stability
Macro policies would need to be on heightened alert to ensure that Singapore's enviable
track record for macroeconomic and financial stability is safeguarded. Let me now elaborate
on the two key thrusts of Singapore's macro stability policies - monetary policy and
macroprudential policy.
Monetary policy: containing inflation in a restructuring economy
Let me start with monetary policy framework. I will cover two areas:
•
First, the continued relevance of the exchange rate in our monetary policy
framework.
•
Second, the calibration of monetary policy responses within this framework.
Relevance of exchange rate as the instrument of monetary policy
MAS' exchange rate-centred monetary policy framework was formalised in the early 1980s.
While other central banks sought to control money supply or interest rates, MAS has chosen
to focus instead on the exchange rate as its monetary policy tool to keep inflation in check.
The exchange rate-centred framework has served Singapore very well for over three
decades. As I mentioned earlier, Singapore has had one of the best inflation records in the
world despite enjoying one of the fastest rates of economic growth.
Let us quickly recall why the exchange rate is MAS' chosen tool of monetary policy.
Singapore is a small and extremely open economy. Total exports and imports of goods are
each well in excess of 100% of GDP.
•
Imports make up 40% of domestic consumption; the exchange rate is thus a
powerful tool to moderate the impact of foreign price changes on domestic inflation.
•
Exports are the chief driver of economic growth; and the exchange rate, as a key
factor affecting export demand, is thus also an effective means for managing
aggregate demand and hence overall inflationary pressures.
But every now and then, analysts and commentators ask whether the exchange rate-centred
monetary policy has outlived its usefulness and whether a switch to interest rate targeting or
inflation targeting would make better sense. With the pickup in inflation in recent years, these
questions have been more frequently raised.
Let me assure everyone that, every few years, MAS itself conducts a review of whether the
exchange rate continues to be the most appropriate tool for Singapore's monetary policy. Let
me share briefly the outcome of these studies as they relate to three questions.
First question: with most of recent inflation in Singapore attributable to the imputed cost of
accommodation services and car prices, is the exchange rate a less relevant tool? It is true
that imputed rentals on owner-occupied accommodation accounted for about a quarter of
overall inflation during 2010-2012. But if MAS had not let the Singapore Dollar appreciate,
CPI-All Items inflation would have been around 2.5% points higher in 2012. Rising housing
rents and car prices do not undermine the importance of the appreciating exchange rate in
restraining price increases in the broader basket of goods and services consumed by people.
Second question: with the principal threat to consumer and asset price stability emanating
from easy monetary conditions and low real interest rates globally, shouldn't MAS abandon
the exchange rate target and seek to control domestic interest rates instead? Well, this is not
as straightforward as it might appear.
First, in an open economy setting, higher interest rates will attract even more capital inflows
to Singapore, especially given our strong macroeconomic fundamentals and persistently low
foreign interest rates. This could fuel further asset price inflation.
Second, the hike in interest rates would have to be very aggressive for it to dampen demand
for credit, and tame asset prices. This would mean a sharp appreciation in the exchange
rate, which would impose significant collateral damage on the broader economy. Indeed,
some regional countries with interest rate regimes are facing the dilemma between raising
rates to curb credit booms and preventing the spillovers on capital inflows and their
exchange rates.
On balance, a switch to a regime of managing interest rates will be highly destabilising.
There are potentially unpredictable costs associated with a shift in the monetary policy
regime, quite apart from its limited impact on the other broader and more predominant
sources of underlying price pressures in the economy.
MAS' assessment has been corroborated by Professor Ilian Mihov, Professor of Economics
at INSEAD. His pioneering academic work has demonstrated that for an open economy like
Singapore, a monetary policy response based on the exchange rate delivers superior
economic welfare outcomes compared to an interest rate regime. In particular, the exchange
rate is better able than the interest rate to reduce volatility in output and inflation.
Third question: with the gradual shift in Singapore's economic structure towards services
(which are typically regarded as being non-tradable), does the exchange rate have as much
impact on aggregate demand and prices in the economy? It is true that services have indeed
contributed more to GDP growth recently. But a significant portion of these services are
exportable, such as financial, IT and professional services. External-oriented manufacturing
and services sectors together continue to account for more than half of Singapore's GDP.
The fundamental structure of the economy as an export-dependent one has not changed.
Firms - both MNCs and SMEs - have consistently highlighted the importance of keeping the
exchange rate stable for planning and investment purposes. The exchange rate continues to
play a key role in household and business decisions, and is an important equilibrating price
for the economy.
Calibration of monetary policy responses
So, the monetary policy framework centred on the exchange rate remains valid. But has its
calibration been sufficiently responsive to recent challenges to price stability?
The chief consideration underpinning the stance of monetary policy in recent years has been
to anchor inflation expectations and contain the risk of a wage-price spiral arising from the
short-term effects of economic restructuring.
Since April 2010, the policy band of the Singapore Dollar nominal effective exchange rate
has been on a modest and gradual appreciation path. The nominal effective exchange rate
has strengthened by about 3% per annum on average during this period. Within this overall
tightening stance, MAS has allowed a temporary increase in core inflation to accommodate
some of the changes in relative prices. This is to signal resource scarcity and stimulate
behavioural shifts. Policy should not be so tight as to hinder the ability of firms to restructure.
The tight monetary policy stance since April 2010 has been effective in containing inflationary
pressures and keeping the economy on an even keel. It has had three important effects.
First, the tighter monetary policy stance has successfully restrained imported inflation despite
significant price pressures in the external environment during this period.
• In foreign currency terms, wholesale price inflation among Singapore's major trading
partners averaged around 5% per annum from 2010 to 2012.
• In comparison, overall imported inflation in Singapore dollar terms has been fairly
benign, averaging slightly less than 2% per annum in this period.
Specific examples illustrate well the efficacy of the exchange rate in dampening imported
inflation.
•
Global oil prices have risen by an average of 16% per year in 2010-2012. However,
local petrol pump prices have only increased by 8%.
•
Global food prices, as measured by the IMF Food and Beverage Price Index, rose
by 9% per annum during this period, but domestic food prices increased by just 2%.
Second, the stronger Singapore Dollar has dampened inflation indirectly by moderating the
demand for our exports. In turn, this has eased the demand pressure on domestic resources
such as labour and industrial space. This has reduced business cost pressures and thus
overall inflation.
Third, the tighter monetary policy stance has nudged the level of output closer to its potential,
thus preventing the economy from overheating. The positive output gap is projected to
narrow from nearly 4% of potential GDP in 2010 to around 1% this year.
MAS' policy stance has begun to yield results. Both CPI-All Items inflation and MAS Core
Inflation have eased from their recent peaks.
•
CPI-All Items inflation has fallen from 5.5% in Q3 2011 to 4.0% in Q1 2013.
•
At 1.6% in the first quarter of this year, MAS Core Inflation is running at nearly half
the pace seen a year ago.
But there is no room for complacency. The pace at which business costs are passed through
to consumer prices could pick up in the latter half of this year. MAS will remain vigilant in
ensuring that the recent gains in controlling inflation are sustained.
Macroprudential policies: augmenting monetary policy to promote economic and
financial stability
Let me move on now to macroprudential policy. This is the new buzzword in central banking
circles. It has not been much referred to in Singapore, but we have been applying
macroprudential policies for some time now.
I will describe now the workings of macroprudential policies in Singapore, explaining why
they are necessary in our context, and how they have been applied.
Why macroprudential policy
The conventional thinking pre-crisis was based on two assumptions:
•
First, asset prices did not matter much. Central banks therefore focused on
consumer prices and placed less emphasis on asset prices.
•
Second, if risks in individual financial institutions were well controlled, the financial
system as a whole would generally be safe. Regulators therefore focused on the
safety and soundness of individual institutions and paid less heed to systemic risk.
The collapse of the real estate markets in America and Europe, the breakout of the Global
Financial Crisis, and the contagion of risk to seemingly sound financial institutions - against
a backdrop of relative macroeconomic stability - showed both assumptions to be wrong.
Thus was born macroprudential policy - which focused on the health of the financial system
as a whole and its interactions with the macroeconomy, particularly developments in liquidity,
leverage, and asset markets. In many emerging market economies, macroprudential policy
has become an important complement to monetary policy to help secure economic and
financial stability.
In Singapore, the focus of macroprudential policy has been to promote sustainable asset
prices. Asset prices matter for four reasons.
First, volatile asset prices pose a risk to financial stability, especially when a run-up in asset
prices is financed by easy credit and accompanied by a build-up in leverage in the economy.
When asset prices correct, financial institutions' vulnerability to default and loss increases.
Second, asset price inflation is as distortionary as consumer price inflation. Both create
uncertainty, misallocate resources, discourage productive investment, and ultimately drag
down economic growth.
Third, asset prices have important feedback loops with consumer prices. Rapidly rising asset
prices raise general inflation expectations and also directly affect rentals and
accommodations costs that go into the consumer price index.
Fourth, asset purchases financed by excessive borrowing on the expectation of future capital
gains undermine financial prudence. If households or corporates build up leverage during
periods of low interest rates, they will be vulnerable when interest rates normalise.
What can central banks or governments do about asset bubbles or the leverage cycle? An
oft-cited reason for not doing anything is that we cannot reliably determine whether asset
prices have overshot fundamentals or whether leverage has reached unsustainable levels.
But the issue is not whether we can establish if there is an asset bubble or not. The issue is
whether the rise in asset prices is creating negative spillover effects on the economy or
whether a future sharp reduction in asset prices will lead to instability or serious dislocations.
If the assessment is that it would, we have to act proactively to moderate prices now. And
this has indeed been the approach taken by MAS and the government with respect to
property prices.
How macroprudential policies have been applied
Singapore applied macroprudential tools as early as 1996, to help cool an overheated
property market. But it is only since 2009 that macroprudential policies have been applied in
a more concerted and calibrated fashion - again to help moderate price increases in the
residential property market. Following the Global Financial Crisis, the confluence of low
interest rates, firm domestic demand underpinned by sustained income growth, and supply
shortages in the residential property markets caused home prices to rise rapidly. This had
implications for both price stability and financial stability.
As rentals increased on the back of rising property prices, imputed rentals on
owneroccupied accommodation accounted for about a third of overall inflation during 2011-2012.
CPI-All Items inflation averaged 4.9% per annum during this period. MAS was concerned
that this would unhinge general inflation expectations and spill-over into more rapid wage
growth across the economy.
At the same time, the stock of mortgages surged by about 70% from end-2009 to end-2012,
posing risks for financial stability. To be sure, there was little imminent danger. Households'
net asset positions were still strong, with the aggregate household debt-to-asset ratio stable
at around 16%. The non-performing loan ratios for mortgages remained low at 0.25%, and
the amount of housing loans in negative equity was negligible.
But if domestic income growth faltered or if the global interest rate cycle turned abruptly,
mortgage financing burdens could escalate. Households' balance sheets could deteriorate if
home prices fell, as much of the increase in household wealth had been driven by a rise in
the value of property assets. The government was thus concerned that households were
over-extending themselves in the low-interest rate environment. If a sufficiently large number
of borrowers ended up in distress, financial institutions would also come under stress,
thereby posing risks for financial stability. Since neither monetary policy nor financial
supervisory policy could directly address the property market, the government had to resort
to macroprudential policies.
However, unlike monetary policy which has a single instrument and a clear target,
macroprudential policy requires a multi-dimensional approach. This is because there is no
single instrument that has a stable and reliable relationship with financial stability or asset
price stability. Each is influenced by a variety of factors.
Macroprudential policy has thus relied on a range of policy instruments. In fact, many of
these instruments are not at the disposal of MAS but involve other government agencies.
The conduct of macroprudential policy has entailed a co-ordinated approach across MAS,
the Ministry of Finance (MOF), and the Ministry of National Development (MND).
MAS, MOF, and MND, worked in concert to implement several rounds of macroprudential
measures to help cool the property market:
• MAS has progressively lowered the loan-to-value ratios on property loans and
capped mortgage tenures at a maximum of 35 years.
• MOF has successively raised taxes on property transactions, in the form of the
Sellers' Stamp Duty and the Additional Buyer's Stamp Duty.
• MND has ramped up land sales for residential property developments.
Property prices finally appear to be stabilising. The annual increase in private residential
property prices slowed significantly from 18% in 2010 to 5.9% in 2011, and further to 2.8% in
2012. In sequential quarter-on-quarter terms, price increases have dipped below 2%.
The motor vehicle market is another example of macroprudential policy in action, this time
complementing monetary policy in addressing concerns regarding consumer price stability.
Singapore has perhaps the most stringent restrictions on car ownership in the world. Anyone
who wishes to register a new vehicle in Singapore must first bid for a Certificate of
Entitlement (or COE), which represents a right to vehicle ownership and use of our limited
road space for 10 years. The number of COEs is tightly controlled, so as to minimise the
number of cars on the road.
As the supply of COEs dwindled and demand for cars remained firm on the back of strong
income growth and low interest rates, COE prices rose rapidly in the last three years. At their
peak early this year, COE prices averaged around $90,000, nearly five times the level in
January 2010. This in turn drove up the overall inflation rate, and started having spillover
effects on the rest of the economy and shaping price expectations more generally. There
was also a growing risk that buyers were over-extending themselves by purchasing more
expensive cars, given the low interest rate environment.
In February this year, MAS announced measures to restrict the financing of car purchases
for private use. Buyers were limited to borrowing only 50-60% of the total purchase price of
the car. Loans had to be repaid within five years. COE premiums for cars have adjusted
downwards by about 25%.
Macroprudential policy in Singapore is still work-in-progress, as is the case elsewhere. The
measures have achieved some degree of success in the property and car markets but it is
too early to declare victory. As with traditional macroeconomic policy, these macroprudential
measures will be recalibrated as market conditions change.
There are many unknowns in the theory and practice of macroprudential policy. We need to
better understand the transmission mechanisms through which our various measures
operate, their inter-relationships with one another, and unintended consequences or
distortions they may create. The field is ripe for further research and, I hope, will challenge
the intellectual curiosity of scholars, such as those assembled here this evening.
In fact, the ABFER can play a very important role in this regard. Policymakers all over the
world, including us here at the MAS, have been thrust into a vastly different environment. We
need to update existing policy paradigms and even develop new ones. It is my hope that the
collaborative network created by the ABFER will help foster a vibrant research culture and
provide thought leadership on the important policy debates confronting this part of the world.
MAS is happy to sponsor and support the ABFER.
Conclusion
Let me summarise my main points.
The macroeconomic landscape for MAS has become more complex, with external and
domestic forces interacting in unprecedented ways.
•
Externally, Singapore is facing a wall of money and rock-bottom interest rates that
could potentially set off asset market bubbles that could in turn have knock-on
effects on consumer price stability and financial stability.
•
Domestically, we are facing a demographic cliff that will tighten labour markets and
could potentially set off a wage-price spiral that could unhinge inflation expectations.
Macro policies will be on heightened alert to ensure that economic stability and financial
stability are safeguarded as Singapore navigates this new landscape. We are well placed to
deal with the risks ahead.
• Our exchange rate-centred monetary policy remains fit for purpose and will continue
to focus on keeping inflation contained.
•
Our macroprudential policies will complement monetary policy and financial
supervisory policies to secure sustainable asset prices and financial stability.
•
Most of all, Singapore's fundamentals remain sound. Fiscal prudence, financial
discipline, minimising debt and living within our means, will provide us policy space
and buffer to weather whatever comes ahead. This is an advantage most countries
do not have.
I wish you a successful and enlightening conference. Thank you.