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Stable Exchange Rate

A stable exchange rate is important for the domestic sector in Singapore
because price stability helps to reduce speculation and unnecessary menu
and shoe leather costs, wastage of resources, and uncertainty of income
distribution, especially for the lower-income groups. On an international
scale, price stability helps to reduce uncertainties in the foreign exchange
market (forex) and make the rate of returns more definite in order to attract
investments. The stable exchange rate also provides investors with
confidence to increase their investments as well as enhance trade
possibilities. AS trade is 300% of the Singapores GDP, an increase in trade
will lead to a steady rate of economic growth. Hence ore goods and services
will be available for consumption, which can improve the standard of living. It
can also maintain the countrys export competitiveness, which in turn leads
to full employment and greater productive use of resources (labour),
especially in Singapore. This can in turn reduce poverty, social tension and
the opportunity cost for the government to allocate resources to support the

Benefits of Singapores exchange-rate policy

The position of the MAS is to allow for gradual appreciation of the exchange
rate. This also resolves a slew of other microeconomic and macroeconomic
objectives when the Singapore currency is appreciated.
Monetary policy in Singapore has been centred on the exchange rate. The
MAS has chosen to anchor its monetary policy to the exchange rate, either
by pegging the value of the Singapore dollar rigidly to another currency or by
managing it more flexibly against a basket of foreign currencies.

Increase in export earnings and improvement in

capital account, economic growth and employment
Changes in the exchange rate are aimed at changing the price of exports
and imports to influence eternal demand to achieve the macroeconomic
objectives of the government. Assuming that the Marshall-Lerner Condition is
satisfied, where the sum of price elasticity of demand for exports and
imports is greater than one, the value of the net exports will rise. For
example, an appreciation of domestic currency decreases the price of
exports in foreign currency and imports become relatively cheaper in the
domestic currency. This leads to an increase in the quantity of exports and a


decrease in quantity of imports. Being small, this implies that Singapore has
a small domestic market and hence has to rely heavily on foreign markets to
export its goods, indicating its high degree of openness to foreign trade.
Singapores manufacturing exports have very high import content and thus
by appreciating the exchange rate of the Singapore dollar, it can keep
competitiveness. With a price-elastic demand, the low price of tis exports can
lead to a more than proportionate increase in the quantity demanded for its
exports, thus increasing the export revenue earned. This subsequently helps
to achieve a healthy current account balance a higher actual economic
growth and employment.

Decrease in cost-push inflation

Singapores small size and its lack of natural resources, such as crude oil,
iron and steel, means that the country has to import even the most basic
daily requirements and at the same time export to pay for these
requirements. This has resulted in a very open trade policy with very few
import restrictions. Changes in the exchange rate to offset changes in foreign
price levels thus have a significant effect on imported inflation. This means
that by appreciating its exchange rate, Singapore is able to keep the price of
its imports low so that it can reduce its rate of inflation due to arising from
the high price of imports, lowering its costs of production. By keeping the
prices of these imported raw materials low, cost-push inflation in the country
is lowered.

Why traditional monetary policy is ineffective in the

Singapore Economy
Changes in interest rates are made to change the domestic demand of
consumption and investment expenditure to achieve the governments
macroeconomic aim. A rise in the interest rate will increase the cost of
borrowing, thus reducing the profitability of investment and lowering the
level of investment. At the same time, households will increase their savings
and cut back on their consumption on credit. Hence, as the level of
aggregate demand falls due to a fall in consumption and investment
demand, the general price level falls, leading to a fall in demand-pull
The effectiveness of any monetary policy depends on how responsive
investment changes are to changes in the interest rate. A monetary policy is
more effective when the marginal efficiency of investment (MEI) curve tends
to be interest-elastic. Due to the existence of many MNCs in Singapore,
which can draw funds from their parent companies, the interest rates is not
an important factor in influencing their investment level in Singapore. Hence


investing in Singapore is interest-inelastic due to the presence of foreign

direct investments. Other factors that determine marginal efficiency of
capital, such as the quality of workers, political stability and infrastructure
support, are much more crucial factors.
Singapores role as an international financial centre causes it to adopt a free
baking policy. With the large presence of foreign banks and foreign direct
investments, the MAS cannot effectively change the money supply because if
the MAS were to raise the amount of cash reserves that banks have to keep
aside so that they have less reserves to lend, foreign banks can resort to
external funds. As a small and open financial hub, Singapore has to follow
international trends in the interest rate to avoid large capital flows. Too great
variation can cause instability of the exchange rate due to large capital
flows. Thus Singapore is a price-taker in terms of interest rate. Likewise,
Singapores interest rates are largely determined by foreign interest rates
and market expectation of movement in the domestic interest rate over a
long period of time can be thwarted by a shift of funds into or out of
Singapore. The interest rate influence domestic demand, which makes up a
smaller percentage of the GDP than external demand does. Thus, changes in
interest rates have a smaller impact on the GDP than the exchange rate,
which influences external demand. Therefore, Singapore, which is dependent
on eternal demand for growth, has elected to focus on exchange rate instead
of the interest rate.

Due to the volumes of its exports and imports, Singapores exchange rate
policy is the most effective policy for achieving its key macroeconomic goals.
The exchange rate policy that the MAS has adopted has helped Singapore
achieve price stability in the last few decades. However, the record of low
inflation in Singapore can also be attributed to the continued use of supplyside policies. Furthermore, this modest and gradual appreciation has instilled
greater investor confidence in Singapores currency and this has even
attracted large MNCs to set up its headquarters in Singapore. Due to
Singapores sound economic policies, such as its exchange-rate policy,
supply-side policy and trade policy, this has led to greater economic growth
for Singapore, both in the short run and the long run.