Monetary Policy in Singapore and the Global Financial Crisis

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b1110

Challenges for the Singapore Economy

tightening during an upswing. After all, accommodative monetary

policy after the bust would not only help the financial sector to cope

with balance sheet vulnerabilities but will also soften the blow on

aggregate demand.

A second argument against using monetary policy to counter

potential bubbles is that the central bank already has too many objec-

tives to be achieved with a limited range of policy instruments.

Indeed, perhaps monetary policy should serve exclusively as a

counter-cyclical tool and asset price fluctuations that do not affect

inflation within the central bank’s forecast horizon, that is one to two

years, should be ignored (Bernanke and Gertler, 2001).

This fits in with those who feel that central banks, especially in

emerging economies, already have a difficult job trying to achieve a

range of goals simultaneously. For example, by late 2009 foreign

funds had begun to flow rapidly into emerging Asia and in a world of

mobile short-term capital flows and volatile exchange rate move-

ments threatened to create bubbles in stock and property markets as

investors anticipated higher returns than in developed countries

where interest rates were historically low. The dilemma is that if Asian

central banks respond by forcing up interest rates through tighter

monetary policy this would have the perverse effect of attracting even

more foreign capital. Moreover, if their currencies are appreciating

because of a fall in the US dollar, this puts pressure on their central

banks to intervene in the foreign exchange market to offset a poten-

tial loss of export competitiveness by selling their own currencies. But

this has the effect of further increasing domestic liquidity. There are

no easy fixes and adding asset price bubbles into the equation can

only make life more difficult for central banks.

Linked to this is the view that using monetary policy to lean

against asset prices will complicate central bank communication to

the public. In particular, the use of the word “bubble” could lead to

misinterpretation and cause asset prices to react in unpredictable

ways. For example, tightening of monetary policy by the Bank of

China in January 2010 led to a sharp fall in stock prices in Shanghai.

Moreover, monetary policy is not the only policy that can mitigate

asset price bubbles. Fiscal and macro-prudential policies might offer

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