Background on Monetary Policy in Thailand free essay sample

To explain about Domestic Monetary Policy and External Monetary Policy, The last target in the economy is output and price. M increase means expansionary monetary policy and M decrease mean tight monetary policy. Expansionary monetary policy aims to increase aggregate demand and economic growth in the economy. It involves cutting interest rates or increasing the money supply to boost economic activity. In Domestic monetary policy, lower interest rates make it cheaper to borrow; this encourages firms to invest and consumers to spend. Moreover, it reduces the cost of mortgage interest repayments. This gives households greater disposable income and encourages spending. Lower interest rates reduce the incentive to save. However, in external monetary policy, using expansionary monetary policy reduce the value of baht according to lower interest rate making exports cheaper and increase export demand. So, the demand of good and service in the overall economy will increase. Excess demand of good and service will adjust price to increase also. Monetary policy framework The monetary policy framework in Thailand can be divided into three periods as follows. The ? st monetary policy regime was the pegged exchange rate. This regime had been adopted after the Second World War. However, when a greater degree of international capital ? ow has been allowed; a monetary policy regime with ? xed exchange rate became one factor that led the country to an excessive external borrowing and ? nancial instability afterwards. After letting the baht ? oat on the July 2, 1997; the Bank of Thailand had initially maintained high short-term interest rates as one mechanism that aimed at preventing the baht from substantial depreciation. Simultaneously, the Bank of Thailand started targeting monetary aggregates within a ? nancial programming approach to ensure macroeconomic consistency and to achieve price stability and sustainable economic growth as well. Therefore, daily liquidity management was pursued in order to prevent excessive volatility interest rate and to ensure that there was enough liquidity in the Thai ? nancial system. Later on, when Thailand had exited the IMF program; the Bank of Thailand formally adopted in? ation targeting in May 2000. The change in monetary policy framework resulted partly from the fact that the Bank found less stable relationship between money supply and output growth. Moreover, the Bank also reappraised its domestic and external environment and found that monetary targeting would not appropriate for the Thai economy anymore. Under the third regime of monetary framework, an in? ation targeting, the Bank implements its monetary policy by in? uencing short-term money market rates through the selected key policy rate. The Bank of Thailand currently uses the 14-day repurchase rate as its policy rate. The Monetary Policy Committee signals shifts in monetary policy stance through an announcement of change in the key policy rate. The in? ation targeting allows Thai monetary policy to be able to cope with shocks in the domestic economy without relying on a relationship between money and in? ation. Moreover, as a range of in? ation is announced to the public; this target has become one of the means to communicate to the public. The more transparent the communication; the more accountability could be achieved as in? ation targeting provides a commitment to the public. Thus, economic agents could incorporate information on in? ation into their decision-making process. In addition, the public could easily observe the effects of Bank of Thailand policy implementation; the success of the implementation will lead to greater credibility earned by the Bank of Thailand. Under in? ation targeting framework, when there is an increasing in an aggregate demand which eventually in? uences general price level; the monetary authority would tighten a monetary policy. Consequently, in? ationary pressure would be subdued. The Bank of Thailand conducts open market operations by undertaking transactions in ? nancial markets to affect the aggregate level of reserve balances available in the banking system and short-term interest rates as well. Open market operations are the most actively use instrument to maintain the policy rate; in order to maintain the policy rate the Bank regularly injects and absorbs liquidity through the market as well as acting as a matched-principal broker. Standard tenors are 1-day, 7-day, 14-day, 1-month,2-month, 3-month and 6-month. Nonetheless, the most active tenors are overnight and 14-day. Current monetary policy formulation under the inflation targeting regime (2000-2008) 1. The Monetary Policy Committee (MPC) sets out monetary policy in order to attain price stability conducive to sustainable economic growth. With its most recent Inflation Report, the MPC also began to monitor factors contributing to external stability and financial imbalances. 2. The MPC’s policy target is core inflation (excluding raw food and energy) of between 0 and 3. 5% (quarterly average). In the event the target is missed, the MPC is required to explain the reasons to the public. . The BOT has developed a macroeconomic model to forecast economic conditions and the inflation outlook. The use of core inflation as the policy target Core inflation is expressed in terms of year-on-year percentage change of the Consumer Price Index (CPI) that excludes fresh food and energy prices. The rationale for the exclusion of these prices i. e. , rice, flour, cereal products, vegetables, fruits, electr icity charges, cooking gas, and gasolineis that they are highly volatile in the short run as a result of factors beyond the control of monetary policy. Retaining these items in the target measure could therefore lead to too frequent changes in monetary policy stances and may also exacerbate the economic hardship in certain circumstances. For example, if the prices of fresh food and energy are rising, a tight monetary policy may worsen a situation in which the public’s purchasing power is already depressed. The exclusion of fresh food and energy prices thus not only helps decrease the volatility of core inflation but also makes it a better measure of the underlying trend of inflation that stems from demand pressures, otherwise known as the second-round effect. Despite the exclusion of fresh food and energy prices, information regarding changes in the general price level is still reflected in core inflation movements, as core CPI accounts for roughly three-fourth of headline CPI. In addition, historical data shows that despite some deviations in the short run, core inflation closely tracks headline inflation (CPI inflation) in the long run. Therefore, the maintenance of price stability in terms of core inflation will eventually lead to overall price stability in the long run. Setting the core inflation target at between  0. 0-3.   per cent, based on: * The ability of people in various groups of the economy to adjust to changes in the price level, particularly retirees who derive income mainly from interest income from savings, fixed-income employees, and laborers who have low bargaining power. Such groups may be adversely affected by a high level of the inflation target, as their income often fails to catch up with inflation which subse quently erodes their purchasing power. * Consistency with inflation of Thailand’s trading partners. Over the past 10 years (1999-2008), inflation of Thailand’s trading partners averaged at around 1. 8 %. Ensuring that Thailand’s inflation rate is in line with those of trading partners enhances export price competitiveness. Under the inflation targeting regime, one of the most critical responsibilities of the BOT is the achievement of price stability. Indeed, since the adoption of inflation targeting in 2000, the BOT has never once missed its core inflation target. Before the current regime was adopted, core and headline inflation appeared to track each other, with their means relatively close. Core inflation was chosen as the target due to its lower volatility. However, given that increases in oil and food prices are no onger a temporary phenomenon, core and headline inflation appear to be diverging more than before, and so the target for inflation is now under review. Despite its stated objective of targeting inflation, the BOT also monitors financial imbalances that may bring instability to the Thai economy. In each of its meetings, the MPC considers seven areas where financ ial imbalances could occur: the household sector, the real estate sector, external stability, financial institutions, and the financial status of the corporate sector, financial markets and government finance and public debt. Inflation target regime (2009) The MPC and the Minister of Finance have considered the appropriateness of the inflation target for 2009, taking into account various important issues, and mutually agreed to propose a new inflation target for 2009. 1. Retain the use of quarterly target for the continuity of policy conduct. 2. Narrow the target range from 0. 0-3. 5 per cent per annum to 0. 5-3. 0 per cent per annum. The lower bound of the range was adjusted upwards by 0. 5 per cent in order to reduce the probability of deflation, while the upper bound was lowered by the same amount to signal no change in the overall monetary policy stance. The Cabinet approved  the above target range on September 1, 2009. Inflation target regime (2010) The MPC and the Minister of Finance have agreed to maintain the inflation target for the year 2010 at 0. 5-3. 0 per cent per annum, in continuation from the previous year. This target range is considered appropriate and supportive of sustainable economic growth for the following reasons: 1. Low and stable inflation would enable the economy to grow on a sustainable path. 2. The target range of 0. 5-3. per cent per annum would keep  Thailand’s inflation comparable to trading partners and competitors’ inflation rates, which would help maintain the country’s export competitiveness. Inflation target regime (2011) The MPC and the Minister of Finance  have agreed to maintain the inflation target for the year 2011 at 0. 5-3. 0 per cent per annum, in continuation since 2009. This target range is considered appropriate for economic stability and sustainable economic grow th. The Cabinet approved the above target range on December 21, 2010. 3. The low inflation target would help build the confidence of consumers and business enterprises, enabling them to be more confident in making longer-term consumption and investment plans. The Cabinet approved  the above target range on December 22, 2009. Monetary policy decision The MPC deemed the current policy rate appropriate in supporting domestic demand to sustain Thai economic growth. The MPC thus voted to hold the policy rate in its last two meetings. In its meeting on November 28, 2012, the MPC judged that the global economy remained stable and exhibited signs of improvement. US economic data were better than expected, especially in the labor and housing markets, although the fiscal cliff remained a key risk factor. Meanwhile, Chinese and Asian economies also showed signs of improvement. Thailand was poised to expand continuously, with global impact limited only to export-related sectors. Exports were expected to begin recovery in the first half of 2013, on the back of global economic recovery. Meanwhile, private consumption and investment would continue to be the main drivers of economic growth going forward. Inflation pressure stabilized at a moderate level close to the previous meeting. The MPC viewed that as downside risks to growth subsided and with inflation pressure in check, the current policy rate remained accommodative and conducive to growth. The MPC therefore voted unanimously to maintain the policy rate at 2. 75 percent per annum and would stand ready to take appropriate policy action as warranted. In its subsequent meeting on January 9, 2013, the MPC assessed that the overall world economy recovered gradually, with improving signals from the previous meeting, led by the US and China. In addition, the recent agreement to avert the US fiscal cliff helped boost global financial market sentiment. Meanwhile, the Thai economy in 2012 Q4 was likely to expand more than previously assessed. Consequently, economic growth in 2012 and growth projection for 2013 were expected to be higher than previously projected, driven mainly by strong private consumption and investment. Furthermore, the export sector showed incipient signs of a broad? based recovery, while the services sector and tourism expanded robustly. Inflation pressure remained stable, close n to the previous meeting. Nevertheless, the impact of a second? round minimum wage increase warranted monitoring. The MPC assessed that the accommodative monetary policy stance throughout the previous year had significantly shored up private sector confidence, supported post? flood recovery, and helped cushion the economy from the global economic headwinds. The MPC viewed that, with remaining uncertainties in the global economy and inflation forecast within target, the current monetary policy stance was appropriate in supporting domestic demand to sustain growth momentum. The MPC thus voted unanimously to maintain the policy rate at 2. 75 percent per annum. However, the MPC would closely monitor financial stability risks that could arise from persistently high credit growth, rising household debt, and volatile capital flows. Challenges from monetary easing by major economies and implications on Thailand Recent monetary policy implementation by major economies During the past 4-5 years, the global economic crisis and public debt problem in the euro area have caused prolonged recessions in major economies, particularly the US, the euro area, the UK and Japan. Despite many years of low or near-zero policy rates not much positive economic impact has owing to low confidence of the private sector and investors coupled with uncertain income prospects from weak labor market conditions, leading consumers to slow spending, thus creating a drag on recovery. Against the backdrop of longer-than-expected recovery of major economies and zero lower bound limitation on policy rates, many central banks have opted for unconventional measures such as Quantitative Easing (QE) in the US Outright Monetary Transactions (OMTs) in European Asset Purchase Programs in Japan and the UK. These measures have caused the size of central banks’ balance sheets to expand, but the direct economic impact has still been small due to overall weaknesses in financial conditions, leading financial institutions to hold extra reserves instead of giving out loans. Implications to Thailand’s policy implementation Implication on monetary policy in Thailand. Recent weaknesses in major economies have caused Thai exports to slow down during some periods, posing risk to overall economic performance, going forward. Should major economies continue to fail to stimulate growth, greater risk would fall on the Thai economy and ultimately affect monetary policy stance. Nevertheless, the MPC has assessed that Thailand’s flexible inflation targeting (FIT) framework is appropriate to the country’s economic conditions and structure, particularly from its transparency and ease of communication. Moreover, many countries that have also been using this framework also register satisfactory growth performance.