Monetary Policy in Singapore and the Global Financial Crisis

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b1110

Challenges for the Singapore Economy

would depreciate the Singapore dollar to an unacceptable level in

terms of its purchasing power in international markets. On the other

hand, one of the lessons from the credit crunch is that there may be

worse things than inflation, and financial stability, as opposed to price

stability, may need to be incorporated more explicitly into the policy

objectives of central banks.

Allied to this is the controversial issue whether a central bank

should tighten monetary policy preemptively in order to moderate

asset price bubbles before a sudden bust triggers financial instability,

such as a large rise in non-performing loans?

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An asset price bubble is generally characterized as a persistent

increase in an asset price that is not fully justified by fundamentals but

is caused by speculative activity and occurs mostly in periods of easy

credit and high leverage. The buildup in the asset price misalignment

implodes at some point, often unexpectedly, with a sharp correction.

An extreme case of this is what Noriel Roubini (2005, 2009) has

described a ‘monster bubble’ when cheap credit leads to speculative

leveraging in a wide range of risk assets, including commodities.

When central banks eventually tighten monetary policy, the unwind-

ing leads to a crash.

On the other hand, if the burst in economic activity is more akin

to Mishkin’s (2008) ‘echo bubble’, the situation may be far less seri-

ous since it is merely a reaction to a crash caused by loose monetary

policy and ‘irrational exuberance’, such as the 1987 stock market col-

lapse. Since there is no cycle of leveraging against higher and higher

asset values, the bubble will eventually peter out and central banks are

justified in keeping interest rates low.

Figure 7 depicts the Singapore residential property price index and

the share price index from the first quarter of 1985 to the last quarter of

2009. The Singapore housing market experienced several boom-bust

cycles during this period, with an average quarter-on-quarter growth of

1.5%. Sharp appreciations in house prices occurred in periods of rapid

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C. H. Kwan and P. Wilson

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Much of the discussion here has been taken from Chow and Choy (2009). For

more on the debate over the relationship between monetary policy and bubbles, see

Bernanke and Gertler (2001), Mishkin (2008), Roubini (2005) and White (2009).

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