Monetary policy here aims for price stability - or low inflation - for sustainable economic growth. Typically, when inflation risks are high, the Monetary Authority of Singapore (MAS) lets the Singapore dollar appreciate against a basket of other currencies to lower import prices, and also to lower demand for the country's exports.
Singapore's approach contrasts with that of many other countries such as the United States, which use the interest rate to conduct monetary policy. This is a result of Singapore's small size and high degree of openness to trade and capital flows.
According to an MAS staff paper in 2004, the impact of a 1 per cent appreciation in the trade-weighted exchange rate on GDP, exports and CPI is 'considerably greater' compared with a corresponding increase in the interest rate.
Another staff paper in 2009 showed that changes in the exchange rate are quickly reflected in domestic import prices and are fully passed on by the fourth quarter.
What MAS focuses on is the trade-weighted exchange rate. It manages the Sing dollar against an undisclosed basket of currencies of Singapore's major trading partners and competitors. Last year, the country's top trading partners were Malaysia, Europe, China, Indonesia and the US.
MAS allows the trade-weighted exchange rate to fluctuate within a secret policy band. When the rate crosses this band, the central bank steps in to buy or sell foreign exchange to steer it back.
MAS manages the exchange rate by adjusting the slope, level or width of the policy band. A steeper band, for instance, means that the Sing dollar will climb at a faster pace. It can also re-centre the entire band upwards, effectively conducting a one-off appreciation. When market conditions are volatile, it can widen the band to accommodate greater exchange rate movements.
There are periodic reviews of the policy band and MAS typically issues a monetary policy statement every April and October.
The exchange rate policy has been put to the test several times. For instance, in 2001, MAS shifted to a neutral exchange rate policy stance as a global slowdown forced Singapore into a technical recession and brought down inflationary pressures. MAS put the Sing dollar trade-weighted exchange rate on a zero per cent appreciation path, down from one charting a gradual and modest appreciation.
In April 2008, with the economy facing high global inflationary pressures arising from factors such as rising oil and commodity prices, MAS kept the Sing dollar trade-weighted exchange rate on a gradual and modest appreciation path and also shifted the entire policy band upwards.
Maintaining economic competitiveness has not been a key thrust of Singapore's monetary policy. In the aftermath of the 1985 recession, the government sharpened the economy's edge mainly by reducing business and wage costs, especially through a cut in employers' Central Provident Fund contributions.
In May last year, MAS deputy managing director Ong Chong Tee said at a briefing: 'We do not use the Sing dollar with an idea of export competitiveness. Indeed, that competitiveness stems from a much broader set of other factors, for example, innovation, creative products, productivity and so on.'