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Mr. Parrado, an economist in the IMF Monetary and Financial Systems Department, was with the Asia and Pacific Department when this paper was written. Helpful comments were received from Burkhard Drees, Joshua Felman, Khor Hoe Ee, William Lee, Sam Ouliaris, Edward Robinson, Scott Roger, Supaat Saktiandi, Philip Schellekens, Abdelhak Senhadji, Celine Sia, and Mark Stone.
Continued fiscal surpluses since 1980, except for 1987 and 2001/02, has released the MAS of the need to finance the government, allowing it to focus on its primarily responsibility of maintaining price stability.
Nadal De Simone (2000) finds that in about 70 percent of the fiscal years between 1967 and 1995, the actual policy mix in Singapore was a contractionary fiscal policy accompanied by a contractionary monetary policy.
Inflation in Singapore ended around 6 percent annually in the period 1981–82, which contrasts with the OECD average of nearly 11 percent.
During 1999 to 2002, the government also opted to stimulate economic activity by reducing employer contributions to the Central Provident Fund, effectively inducing a real depreciation.
Note that variables in this section that are labeled as monetary policy shock are not computed with a policy reaction function. They are, instead, random components that cannot be explained by the variables in the VAR.
The VAR is performed using log differences in 12 months, except for the two interest rates, which are in levels. In terms of optimal lags, different tests recommend diverse number of lags. For example, the likelihood ratio test (LRT) and the Akaike Information Criterion (AIC) suggest the use of twelve lags; while the Schwarz Bayesian Criterion (SBC) and the Hannan-Quinn Criterion (HQC) advise the use of one lag. This model is specified with twelve lags.
Many studies have found that including commodity prices helps to resolve the so-called price puzzle usually found in the VAR literature, where contractionary monetary policy shocks are related to increases (rather than decreases) in the price level. See Sims (1992), Cushman and Zha (1997), Kim (1999), and Kim and Roubini (2000), among others.
Using quarterly data and GDP in place of industrial production, the exchange rate shock continued to have a relatively low explanatory power for CPI inflation, reaching a maximum of 7.9 percent in the sixth quarter.
The variance decomposition results are similar with different variable ordering in the VAR specification. The impact of the TWI on both output and inflation is also comparable in a VAR specification that excludes the world commodity price index.
In general, major central banks use a short-term interest rate as an operating instrument of monetary policy; however, in the case of Singapore, the MAS uses the trade-weighted nominal exchange rate as its monetary policy instrument.
The use of an optimal weighting matrix implies that GMM estimates are robust to heteroskedasticity and autocorrelation of unknown form. It is worth noting that the GMM technique requires no information about the exact distribution of the error term which, in general, is assumed to be drawn from a normal distribution.
Alternative target horizons for industrial output did not change the results.
The rationale for this behavior could be given by concerns of increasing vulnerabilities in financial markets or uncertainty about the effects of sudden exchange rate changes on financial markets or the economy.
The J-statistics (Hansen (1982)) imply that the over-identifying restrictions of these models are not rejected.
The output gap enters the instrument set for expected inflation. Therefore, the coefficient associated to the output gap reflects the influence on the TWI that is independent of its predictive power for inflation.
At that time, although most market commentators agreed that Asian currencies were massively undervalued, few predicted a rebound so soon.
However, under certain assumptions there is an approximate log-linear relationship between output and marginal costs (see Galí and Gertler, 1999).
Regarding the increase in the volatility of the Singapore dollar after the Asian Crisis, MAS (2003) has explored its impact on the behavior of key macroeconomic variables. The results of that work find that the higher volatility of the exchange rate has not affected the stability of macroeconomic fundamentals, including trade flows.
Since 2001, the MAS has published its Macroeconomic Review, which appears twice a year, in conjunction with the release of the MAS Monetary Policy Statement (MPS). Its main objectives are: “… to provide information on the Economics Department’s analysis and assessment of the GDP growth and inflation developments in the Singapore economy, and in doing so, to share with market participants, analysts, and the wider public, the basis for the policy decision articulated in the MPS.”