An Exchange Rate Policy Rule

The Monetary Authority of Singapore, instead of relying on short-term interest rates or monetary aggregates as its monetary policy instrument, conducts policy by managing the exchange rate. This paper investigates how this operating procedure works. For empirical purposes, it assumes the authorities follow a reaction function that aims the exchange rate at stabilizing expected inflation and maintaining output at potential. The estimated changes in the exchange rate track the actual change relatively well, and the estimated parameters are as expected. Accordingly, they support the hypothesis that monetary policy in Singapore can be described by a forward-looking policy rule that reacts to both inflation and output volatility