## EXCHANGE RATE PASS-THROUGH TO INFLATION IN SINGAPORE

## Source details

**Canonical URL:** [EXCHANGE RATE PASS-THROUGH TO INFLATION IN SINGAPORE](https://www.imf.org/-/media/files/publications/selected-issues-papers/2024/english/sipea2024039.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/selected-issues-papers/2024/english/sipea2024039.pdf.md)
- [Structured JSON version](/-/media/files/publications/selected-issues-papers/2024/english/sipea2024039.pdf.json)

---

### Background: recent inflation and monetary policy
- MAS operates a basket, band, and crawl (BBC) exchange rate-based monetary policy framework using the nominal effective exchange rate (S$NEER) as the short-term policy instrument.
- Channels of influence: ‘imported inflation’ and ‘derived demand’.
- Recent inflation developments:
  - Headline CPI peaked at 7.5 percent in September 2022 and moderated to 3.7 percent in December 2023.
  - MAS core inflation fell to 3.3 percent in December 2023 from 5.5 percent in February 2023.
  - MAS responded with five rounds of consecutive tightening and has remained on pause since April 2023.
- Labor market: remains tight compared to pre-pandemic level.

### Empirical identification, data, and estimation strategy
- Two-stage strategy:
  - Stage 1: identify plausibly exogenous S$NEER shocks using MAS monetary policy meeting-level data. The exchange rate shock η_m^NEER is the residual from:
    ∆S$NEER_m = β0 + β1 S$NEER_{m−1} + Σ_{k=0}^{1} δ_k π_{m,t+k} + Σ_{k=0}^{1} δ_k y_{m,t+k} + η_m^NEER
  - Stage 2: estimate pass-through to prices using local projections (Jordà, 2005) with state dependence on labor market tightness:
    Y_{t+h} − Y_{t−1} = α_h + θ_h η_t^NEER + λ_h η_t^NEER × vac_ratio_t + domestic and global controls + error
- Data coverage and controls:
  - Shock identification: 2000m1–2023m10; monthly estimates of monetary policy shocks set to zero in months without meetings.
  - Inflation and growth forecasts from consensus forecasts at meeting dates.
  - Job vacancy ratio (job vacancy to unemployed persons ratio) used as labor market tightness measure (quarterly).
  - Domestic controls: output gap, lagged inflation, lagged NEER shocks, job vacancy ratio, lagged changes in log manufacturing PPI.
  - Global controls: global output gap, global supply chain pressures index, changes in log global food and oil price indices.
  - Confidence bands: 90 percent confidence intervals based on Newey-West standard errors (robust to autocorrelation).

### Determinants of S$NEER changes (key estimates)
- Model diagnostics:
  - N: 50
  - R-squared: 0.296
- Coefficients (preserve values exactly as reported):
  - S$NEER_{m−1}: 0.036** (0.016)
  - y_{m,t}: 0.001* (0.000)
  - y_{m,t+1}: 0.003** (0.001)
  - π_{m,t}: -0.002 (0.001)
  - π_{m,t+1}: 0.001* (0.000)
  - β0: -0.188** (0.078)
- Interpretation:
  - Model explains about 30 percent of variation in ∆S$NEER.
  - MAS tightens policy when current and next-year growth are expected to be strong and when next-year inflation is expected to be high.

### Main empirical findings on pass-through (identified S$NEER shocks)
- Identification matters:
  - Pass-through estimates are larger when using plausibly exogenous S$NEER shocks (η^NEER) than when using raw changes in log S$NEER.
  - Example: for headline inflation, average pass-through is about twice as large using the identified shocks versus simple S$NEER changes.
- Magnitude and timing:
  - A 1 percent S$NEER appreciation shock leads to a cumulative 2 percentage points reduction in headline inflation in about 9 months.
    - Example interpretation preserved: for an initial inflation rate of 3 percent, a 1 percent appreciation shock in the S$NEER would lead to an inflation rate of about 1 percent in 9 months.
  - For MAS core inflation, a 1 percent appreciation shock leads to about 1 percentage point cumulative reduction over 9 months.
  - Comparison: recent estimates for advanced economies show a pass-through coefficient about 0.1 percentage point cumulatively over 12 months (Carrière-Swallow et al., 2021).
- Persistence:
  - The transmission of exchange rate shocks persists mainly only over about 14 months (except for goods CPI where the impact can persist up to 20 months).
  - Standard horizon in related literature is 12-months; the study also reports results for a 24-months horizon as a robustness check and notes that "the quality of statistical inference within the local projection framework could be weakened at higher projection horizons."

### Role of labor market tightness
- Labor market tightness dampens exchange rate pass-through:
  - Under tight labor market conditions, the marginal impact of a 1 percent S$NEER appreciation represents only about one-fourth of the headline impact and about one-half of the MAS core impact (relative to the normal-condition impacts above).
  - State-dependent computation used: θ_h + λ_h × p75_vac where p75_vac is the 75th percentile of the job vacancy ratio series.
  - Potential channels: tighter labor market often accompanies domestic shocks; derived-demand channel and other demand-side factors can weaken or delay pass-through even when output gap is controlled.
- Alternative labor market measure:
  - Using the Job Vacancy Rate ("the total number of job vacancies divided by the total demand for manpower at the end of the quarter") produces results consistent with the main finding of subdued pass-through under tight labor market conditions and shows a more significant impact of labor market tightness in some specifications.

### Sectoral results: goods versus services
- Pass-through by sector:
  - Goods CPI: a 1 percent appreciation reduces goods inflation by 2 percent cumulatively in 7 months (statistically significant, faster response).
  - Services CPI: a 1 percent appreciation reduces services inflation by about 1 percent (slower and weaker response).
- Under tight labor market conditions:
  - Pass-through to goods CPI is about halved relative to normal conditions.
  - Pass-through to services CPI is about one-fourth of the average effect—services pass-through is severely weakened under tight labor market conditions.

### Robustness checks and alternative specifications
- Robustness exercises include:
  - Including certificates of entitlement (COE) quotas among domestic controls (COE quotas significantly impact private transport component).
  - Controlling for episodes of GST hikes via a dummy variable taking the value 1 in years where a GST hike took place over the period.
  - Redefining goods CPI basket to include "Utilities and other fuels."
  - Using alternative measure of labor market tightness: job vacancy rate instead of job vacancy to unemployed persons ratio.
  - Reporting responses for a 24-months horizon (Figure 7).
- Robustness conclusion:
  - Main results are broadly robust to these alternate specifications and measures.
  - Results with the job vacancy rate show a more significant impact of labor market tightness but remain consistent with the finding of subdued pass-through under tight labor market conditions.

### Policy implications and recommendations
- Exchange rate-based monetary policy serves Singapore well but requires greater vigilance when the labor market is tight.
- Policies designed to ease structural labor market tightness could help support monetary policy in ensuring price stability.
- Suggested policy directions:
  - Enhance existing policies such as Career Conversion Programs to equip workers with skills to ease matching frictions.
  - Address short-term shortages in technology skills and recent shifts in the foreign workforce that have led to skill shortages in sectors such as health and social services.
- Alignment with literature:
  - Findings align with related literature suggesting that addressing inflationary pressures from a tight labor market requires policies that bring labor demand and supply into better balance (reference to Bernanke and Blanchard, 2023).

*Source: sipea2024039, Selected Issues Paper (Singapore), IMF staff calculations.*

### References ____________________________________________________________________________ 21

### EXCHANGE RATE PASS-THROUGH TO INFLATION IN SINGAPORE

### Background: recent inflation and monetary policy
- MAS operates a basket, band, and crawl (BBC) exchange rate-based monetary policy framework using the nominal effective exchange rate (S$NEER) as the short-term policy instrument.
- Channels of influence: ‘imported inflation’ (S$ appreciation lowers S$ prices of imported goods and services) and ‘derived demand’ (S$ appreciation reduces aggregate demand under a positive output gap).
- Recent inflation developments:
  - Headline CPI peaked at 7.5 percent in September 2022 and moderated to 3.7 percent in December 2023.
  - MAS core inflation fell to 3.3 percent in December 2023 from 5.5 percent in February 2023.
  - MAS responded with five rounds of consecutive tightening and has remained on pause since April 2023.
- Labor market: remains tight compared to pre-pandemic level.

### Empirical identification and estimation strategy
- Two-stage strategy:
  1. Identify plausibly exogenous S$NEER shocks using MAS monetary policy meeting-level data (equation (1)). The exchange rate shock η_m^NEER is the residual from:
     ∆S$NEER_m = β0 + β1 S$NEER_{m−1} + Σ_{k=0}^{1} δ_k π_{m,t+k} + Σ_{k=0}^{1} δ_k y_{m,t+k} + η_m^NEER
  2. Estimate pass-through to prices using local projections (Jordà, 2005) with state dependence on labor market tightness:
     Y_{t+h} − Y_{t−1} = α_h + θ_h η_t^NEER + λ_h η_t^NEER × vac_ratio_t + domestic and global controls + error
- Data coverage for shock identification: 2000m1–2023m10; monthly estimates of monetary policy shocks set to zero in months without meetings.
- Controls and variables:
  - Inflation and growth forecasts from consensus forecasts at meeting dates.
  - Job vacancy ratio (job vacancy to unemployed persons ratio) used as labor market tightness measure (quarterly).
  - Domestic controls: output gap, lagged inflation, lagged NEER shocks, job vacancy ratio, lagged changes in log manufacturing PPI.
  - Global controls: global output gap, global supply chain pressures index, changes in log global food and oil price indices.

### Determinants of S$NEER changes (Table 1 key estimates)
- Coefficients and diagnostics (preserve values exactly as reported):
  - S$NEER_{m−1}: 0.036** (0.016)
  - y_{m,t}: 0.001* (0.000)
  - y_{m,t+1}: 0.003** (0.001)
  - π_{m,t}: -0.002 (0.001)
  - π_{m,t+1}: 0.001* (0.000)
  - β0: -0.188** (0.078)
  - N: 50
  - R-squared: 0.296
- Interpretation: model explains about 30 percent of variation in ∆S$NEER. MAS tightens policy when current and next-year growth are expected to be strong and when next-year inflation is expected to be high.

### Main empirical findings on pass-through
- Identification matters: pass-through estimates are larger when using plausibly exogenous S$NEER shocks (η^NEER) than when using raw changes in log S$NEER.
  - Example: for headline inflation, average pass-through is about twice as large using the identified shocks versus simple S$NEER changes.
  - Without accounting for endogeneity, pass-through—especially under tight labor market conditions—may be underestimated.
- Magnitude and timing (using identified monetary-policy-induced S$NEER shocks):
  - A 1 percent S$NEER appreciation shock leads to a cumulative 2 percentage points reduction in headline inflation in about 9 months.
    - Example interpretation preserved: for an initial inflation rate of 3 percent, a 1 percent appreciation shock in the S$NEER would lead to an inflation rate of about 1 percent in 9 months.
  - For MAS core inflation, a 1 percent appreciation shock leads to about 1 percentage point cumulative reduction over 9 months.
  - Comparison: recent estimates for advanced economies show a pass-through coefficient about 0.1 percentage point cumulatively over 12 months (Carrière-Swallow et al., 2021).

### Role of labor market tightness
- Labor market tightness dampens exchange rate pass-through:
  - Under tight labor market conditions, the marginal impact of a 1 percent S$NEER appreciation represents only about one-fourth of the headline impact and about one-half of the MAS core impact (relative to the normal-condition impacts above).
  - Potential channels: tighter labor market often accompanies domestic shocks; derived-demand channel and other demand-side factors can weaken or delay pass-through even when output gap is controlled.
- State-dependent computation: cumulative impact accounting for labor market tightness computed as θ_h + λ_h × p75_vac where p75_vac is the 75th percentile of the job vacancy ratio series.

### Sectoral results: goods versus services
- Pass-through is larger and faster for goods than for services:
  - Goods CPI: a 1 percent appreciation reduces goods inflation by 2 percent cumulatively in 7 months (statistically significant, faster response).
  - Services CPI: a 1 percent appreciation reduces services inflation by about 1 percent (slower and weaker response).
- Under tight labor market conditions:
  - Pass-through to goods CPI is about halved relative to normal conditions.
  - Pass-through to services CPI is about one-fourth of the average effect—services pass-through is severely weakened under tight labor market conditions.

### Robustness checks
- Robustness exercises (summarized):
  - Including certificates of entitlement (COE) quotas among domestic controls (COE quotas significantly impact private transport component).
  - Controlling for episodes of GST hikes (GST hikes historically correlated with periods of tight labor market).
  - Redefining goods CPI basket to include “Utilities and other fuels.”
  - Using alternative measure of labor market tightness: job vacancy rate (total vacancies divided by total demand for manpower) instead of job vacancy to unemployed persons ratio.
- Overall robustness conclusion:
  - Main results are broadly robust to these alternate specifications and measures. Results with the job vacancy rate show a more significant impact of labor market tightness but remain consistent with the finding of subdued pass-through under tight labor market conditions.

*Source: IMF staff calculations.*

### 14.      Finally, we also undertake a robustness check considering a 24-months horizon. Our

### sipea2024039 - 14.      Finally, we also undertake a robustness check considering a 24-months horizon. Our

### Summary of main results
- Exchange rate pass-through to inflation in Singapore is strong once endogeneity is plausibly addressed, with particularly strong effects for the goods components of the CPI basket.
- The transmission of exchange rate shocks persists mainly only over about 14 months (except for goods CPI where the impact can persist up to 20 months).
- Using plausibly exogenous 1 percent appreciation shocks in the S$NEER, cumulative responses of inflation are reported and plotted for headline, MAS core, goods, and services inflation.
- Job market tightness (measured by job vacancy ratios or job vacancy rates) severely weakens exchange rate pass-through, with a larger weakening for service components than for goods components.
- Robustness checks (including controls for Certificate of Entitlement (COEs), GST hikes, redefining goods/services baskets, and alternative job vacancy measures) broadly support the main findings.

### Robustness, horizons, and inference
- Standard horizon in related literature is 12-months; the study extends analysis to a 24-months horizon as a robustness check.
- The transmission of exchange rate shocks is observed to persist mainly over about 14 months; goods CPI impacts can persist up to 20 months.
- Extending the horizon beyond the standard 12-months could weaken the quality of statistical inference within the local projection framework: "the quality of statistical inference within the local projection framework could be weakened at higher projection horizons."
- Figures use 1 percent appreciation in the S$NEER as the shock and show:
  - Blue line: average impact (휃_h).
  - Red line: impact conditional on the 75th percentile of the job vacancy ratio in the sample (휃_h + 휆_h × p75_vac).
  - 90 percent confidence interval in shaded areas based on Newey-West standard errors (robust to autocorrelation).
- Robustness checks specifically include:
  - Controlling for Certificate of Entitlement (COEs).
  - Controlling for GST hikes via a dummy variable taking the value 1 in years where a GST hike took place over the period.
  - Redefining goods and services baskets (e.g., including "utilities and other fuels" in goods).
  - Using Job Vacancy Rate defined as "the total number of job vacancies divided by the total demand for manpower at the end of the quarter."
  - Results also presented for a 24-months horizon (Figure 7).

### Policy implications and recommendations
- Exchange rate-based monetary policy serves Singapore well but requires greater vigilance when the labor market is tight.
- Policies designed to ease structural labor market tightness could help support monetary policy in ensuring price stability.
- Enhancing existing policies such as Career Conversion Programs to equip workers with skills could help ease matching frictions.
- The findings align with related literature suggesting that addressing inflationary pressures from a tight labor market requires policies that bring labor demand and supply into better balance (reference to Bernanke and Blanchard, 2023).
- MAS analysis is cited as indicating persistent matching frictions in the labor market, potentially due to a shortage of technology skills in the short-term and a recent shift in the foreign workforce leading to skill shortages in sectors such as health and social services.

### Data, scope, and methodological notes
- Shocks: plausibly exogenous shocks denoted as (휂_t^NEEER) are used in some specifications.
- Job market measures: job vacancy ratio and Job Vacancy Rate are used; the 75th percentile of the job vacancy ratio is used for conditional pass-through analysis.
- Confidence bands: 90 percent confidence intervals based on Newey-West standard errors (robust to autocorrelation).
- CPI baskets: Appendix I lists the MAS CPI components for Goods and Services and MAS Core components; MAS core goods exclude private transportation category while MAS core services exclude the accommodation (housing) category. Notes indicate some items excluded due to data availability and adjustments described.
- Figures and tables present cumulative responses to 1 percent S$NEER appreciation across headline, MAS core, goods, and services inflation, and across robustness specifications.

*Source: sipea2024039, Selected Issues Paper (Singapore), IMF staff calculations as presented in the provided content.*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2024/english/sipea2024039.pdf_