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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