Using Interest Rates to fight Inflation

Using Interest Rates to fight Inflation

The Monetary Authority of Singapore (MAS) uses the exchange rate, rather than the interest rate, as its chief weapon to fight inflation. However, after 3 rounds of tightening efforts between Oct 2021 and Apr 2022, the SGD has actually weakened about 4% against the USD, from 1.35 to 1.40. Is there more that can be done?

I believe there is. MAS can increase interest rates.

Why mas uses mainly exchange rates and not interest rates

In big countries like the USA, interest rates are used as the primary tool to combat inflation. Raising interest rates makes borrowing more expensive, and since most consumption in an advanced economy is fueled by credit (i.e. borrowed money), it has a deflationary effect by reducing consumption.

However, most of the goods and services consumed by these big countries are produced within the country. Singapore is very different because most of the goods we consume are imported.

This is why in Singapore’s context, the exchange rate is a better tool for managing inflation. Having a stronger Singapore Dollar (SGD) makes imports cheaper for Singaporeans. Therefore, MAS’s policy of using the exchange rate as its primary monetary policy instrument is fundamentally sound.


MAS has announced 3 rounds of monetary tightening between Oct 2021 and Apr 2022. This policy is executed by re-centring the midpoint of the exchange rate policy band and increasing the slope of currency appreciation.

But do you what the MAS actually does to execute the policy?


Yes, you read that right. The MAS does absolutely nothing, Let me explain in detail.

Most of the time, MAS does something, not to keep the SGD strong, but to keep it weak.

For the longest time since the 1980s, Singapore has had a positive Balance of Payments, driven by net exports being greater than imports and also a healthy inflow of investment funds. Thus, there is strong, organic pressure for the SGD to appreciate.

However, a strong SGD makes Singapore’s exports more expensive to foreign customers. Since our economy is heavily dependent on exports, this can have a negative impact on our economy. If exports go down, so too will our GDP, along with jobs in the export sector.

Thus, the MAS seeks to ensure a gradual appreciation of the SGD. It recognizes that the SGD cannot be under-valued forever, but also doesn’t want it to appreciate too quickly and risk creating shocks to our economy.

To do so, it sets an “exchange rate policy band”, which essentially means that it will allow the SGD to trade within a certain band. The band also slopes upwards with time, which allows a gradual appreciation of the SGD.

If the SGD goes too high, MAS will sell SGD to buy foreign currencies such as the USD. The increased supply of SGD lowers its price against the USD. And the foreign currencies MAS buys become what you may know as our “foreign reserves”.

Conversely, if the SGD goes too low and hits the lower limit of the policy band, MAS will sell USD from its foreign reserves to buy SGD, increasing the demand for SGD and propping up its price against the USD. This doesn’t happen often since Singapore has a positive Balance of Payments most of the time but can happen occasionally e.g. when SGD came under a speculative attack in 1985.

For more information on how MAS conducts its monetary policy, you can read their Monetary Policy Operations Monograph.

Thus, the latest MAS statement in Apr 2022 simply means that they will allow the SGD to appreciate naturally without trying to weaken it artificially. But, if it drops to a certain level below their exchange rate policy band, it will intervene by using our foreign reserves to buy SGD in the open spot market.

is it enough?

This policy is fundamentally sound and has worked well for decades. But our situation now is quite different.

Since Oct 2021 when monetary tightening was first announced, the SGD has actually weakened by about 4% from 1.35 against the USD to 1.40. In other words, a weaker SGD has contributed an additional 4% to imported inflation, on top of what was already created due to supply chain issues and the war in Ukraine.

This is not really due to anything happening in Singapore or the weakness of the SGD. It is because of the strength of the USD, against MOST other currencies, including the SGD.

The US Federal Reserve (the “Fed”) has adopted a strong monetary tightening stance and has been increasing interest rates. This creates an inflow of funds from foreign investors into the USA to take advantage of the higher yields. Therefore, the USD has become stronger relative to SGD due to higher demand.

Thus, although the MAS is doing the right thing by allowing the SGD to appreciate naturally, clearly, it is not enough. The proof is in the pudding because the SGD is now weaker compared to Oct 2021 when MAS first started tightening.

Yes, interest rates in Singapore are also creeping up in response to higher interest rates elsewhere in the world, but against the USD, it is not enough. In order to reverse the net outflow of funds to the US, we need to do more to increase interest rates.

Furthermore, the Fed is going to announce even more rate hikes in the future and has shown it is determined to keep doing so until inflation is contained. If we do nothing, the SGD will continue to slide against the USD.

What happens if the SGD depreciates and hits the lower threshold of MAS’s exchange rate policy band? Will the MAS be forced to deplete its foreign reserves, which is almost half of our nation’s total reserves, to support the SGD?

To avoid such a situation, I believe it is better for the MAS to be proactive and start using interest rates as an additional policy lever.


The MAS has many ways to increase interest rates. One way is to borrow money by selling government bonds or MAS bills, with a higher interest rate. This is a beautiful mechanism for fighting inflation, given the current set of circumstances, for a few reasons.

  1. It strengthens the SGD against the USD. Government bonds and MAS bills are sold mainly to institutional investors, who may transfer more funds from overseas to take advantage of the higher interest rates. They need to use their foreign currency to buy SGD in order to buy the bonds/bills, which increases the demand for SGD and props up its exchange rate.
  2. It doesn’t require a budget. Much of the government’s effort thus far has been to dish out direct aid to households, which COSTS taxpayers’ money. However, selling bonds/bills actually RAISES money. While it’s true that the money borrowed eventually has to be paid back, it can be repaid further in the future when inflation is (hopefully) less of a problem. There’s also future interest to be paid on these borrowings, but I would argue it is still more cost-effective in fighting inflation than just handouts.
  3. Higher interest rates reduce demand-pull inflation, which was caused by a rapid re-opening of the economy post-Circuit Breaker. People are less prone to spend on credit (e.g. buying a house or car) because they can’t afford the higher interest.
  4. Some buyers of the government bonds/bills will be banks. This reduces the money supply because the banks, having lent money to the government, now have less money to lend out to consumers and businesses, who may otherwise spend the borrowed money and contribute to demand-pull inflation.
In conclusion

Inflation is a demon that needs to be slain quickly. Allowing it to fester for too long will create what is called the wage-price inflation spiral. Workers demand higher wages to offset a higher cost of living, and businesses raise their prices to pay those higher wages, creating further inflation. It is a vicious cycle. By being slow to react, MAS risks allowing wage-price inflation to take hold.

Also, while doling out aid packages to households does help to make the lives of average Singaporeans easier, it costs taxpayer money. Using government borrowing to raise interest rates, on the other hand, costs much less, and probably has a bigger impact on fighting inflation and easing the pressure on Singaporean households.

I urge the Singapore Government and the MAS to slay sacred cows when necessary and re-look at the policy of not using interest rates to conduct monetary policy.

You have a good weapon (i.e. interest rates), which you didn’t need to use for the past few decades. It wasn’t the right weapon then. But that doesn’t mean it is not the right weapon now.

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