Monetary Policy under Flexible Inflation Targeting: Thailand s s Experience. Dr. Atchana Waiquamdee Bank of Thailand

Transcription

1 Monetary Policy under Flexible Inflation Targeting: Thailand s s Experience Dr. Atchana Waiquamdee Bank of Thailand

2 Overview 2 Introduction Inflation targeting framework in Thailand Challenges ahead and policy issues

3 Monetary policy ultimate objectives 3 Price stability Long-term growth

4 Monetary policy framework 4 Exchange Rate Targeting Monetary Targeting Inflation Targeting No explicit announcement (Just-do-it approach)

5 Exchange rate targeting 5 Pros Low inflation (for developing countries) Stable environment for trade & investment Monetary discipline Cons Under free capital mobility, no monetary policy independence Crisis-prone Losing competitiveness

6 Success of exchange rate targeting 6 Synchronize economic cycles Appropriate level of exchange rate (no macroeconomic imbalance)

7 Monetary targeting 7 Monetary as policy anchor MV = PQ Conditions for success Stable relationship between money and economic variables (growth & inflation) Ability to control

8 Just-do-it approach 8 No explicit announcement for policy anchor Pros Flexibility Cons Lack of transparency discipline Need credibility before adopt

9 Why monetary policy was revised? 9 1. Switch from fixed to a floating exchange rate regime need for a new nominal anchor 2. Rapidly changing world economic and financial environment 3. Growing public awareness of information and news 4. Previous monetary policy not clearly defined

10 The search for a new nominal anchor consistent with flexible exchange rate regime 10 % Change of the exchange rate regime Baht/USD Exchange rate Headline inflation

11 Features of appropriate monetary policy Clear principles and framework 2. Transparent and examinable, consistent with good governance rules 3. Decisions based on sound principles, avoiding personal judgment, and easily communicated to the public 4. Clear responsibility and accountability 5. Promotion of long-term economic development 6. Strengthening of credibility for the central bank and Thai economy

12 General principles of IT 12 Transparency To build up credibility Independence Accountability

13 13 II. Inflation targeting framework in Thailand

14 Current framework 14 Policy goal: Price stability Policy target: 0-3.5% quarterly average core inflation rate Policy instrument: 1-day bilateral repurchase rate Policy tool: Macroeconomic Model (BOTMM) Responsibility: Monetary Policy Committee (MPC) Communications policy: Inflation Report, press conference

15 Policy goal: price stability 15 Price stability is the overriding objective, in support of sustainable long-term growth. Policy widely understood and agreed upon. Clear, credible, and consistent. Cooperation and regular consultation between BOT and the government (under the new BOT Act).

16 Choice of inflation measure to target (Core inflation) 16 CPI excluding some items that cannot be influenced by monetary policy, and retaining sufficient price information Core inflation has less variation but on average is close to headline inflation in the long run Targeting core inflation is the control of long-run inflation such that monetary policy does not have to accommodate supply shocks Mean Percent Volatility (S.D.) Before IT 1986 Q Q1 Headline Core

17 Policy target: core inflation 17 based on prices of goods and services in the CPI basket but excludes raw food and energy items: Rice and cereal products Meat, poultry, and fish Vegetables and fruits Eggs and milk products Benzene and diesel Cooking gas and electricity

18 Choices of items excluded from core inflation for the case of Thailand 18 Weight Mean S.D. Food 38% Raw food 16% Energy 6% Controlled price 6% Indirect tax 9% Raw food and energy 22% Headline inflation 100% Sample 1993: :12

19 % YoY 12 Core inflation closely tracked headline inflation in the long run 19 8 Headline - Core Core CPI Headline CPI 4 0 IT since May

20 Target point or range (0-3.5%) 20 Criteria in choosing the inflation target Relatively low in comparison with past inflation Consistent with inflation trend of Thailand s trading partners and structure of the Thai economy Chosen target range enhances export competitiveness and leads to currency stability Does not pose constraint on economic recovery Cushions temporary economic shocks and minimizes need to adjust monetary policy frequently

21 Policy instrument: 1-day bilateral repurchase rate 21 The use of 1-day bilateral repurchase rate as the key policy rate is expected to: provide a transparent monetary policy signal. provide a framework for a more effective transmission mechanism.

22 Transmission mechanism of monetary policy Time Horizon (8 Quarters) 22

23 Movements in policy rate (RP1D) 23 % p.a Interbank 2 1 RP 1D

24 Monetary policy transmission mechanism 24 % p.a MLR Policy rate RD3M

25 Policy tool: Macroeconomic model (BOTMM) 25 Represents relationships between key variables in Thai economy. Covers 4 main economic sectors (real, government, external, and monetary) and price indices. Analyzes the impact on the economy from various exogenous shocks and policy changes.

26 Components of macroeconomic model 26

27 Macroeconomic model : Policy optimization 27 Minimize Loss Function : * L( π, y ) (1/ 2)[ g( * ) 2 r( y y ) 2 t = π π + ] * π t π Where = The difference between forecasted inflation * y t y and targeted inflation at time t = The difference between forecasted output and potential output at time t Min L( π i t y = 0 + i t + i Subject to the macroeconomic model t n t, t )

28 Using optimal control to assist decision making 28 Models & Optimal Control Monetary Policy Rules Results Put in quantitative form Policy Makers Judgement Interpretation Economic Condition Intuition Monetary Policy Discretion Decisions

29 GDP growth forecast adjusted for risk factors (as of January 2008) Annual percentage change (%) Q Q Q Q Q Remark: The fan chart covers 90 per cent of the probability distribution 2

30 Probability distribution of the GDP growth forecast 30 (Unit: per cent) < > 6.5 Old (Oct 07) New (Jan 08) Probability 2008 Old (Oct 07) New (Jan 08) New (Jan 08)

31 Core inflation forecast adjusted for risk factors (as of January 2008) 31 4 Annual percentage change (%) Q Q Q Q Q Remark: The fan chart covers 90 per cent of the probability distribution -1

32 Probability distribution of the core inflation forecast 32 (Unit: per cent) < Old (Oct 07) Probability New (Jan 08) New (Jan 08) > 3.5

33 Benefits of fan charts 33 What are the benefits of having fan charts? MPC can voice their opinions. MPC can signal risk clearly. MPC can judge beyond the model. Helps shape public expectations of GDP growth and inflation.

34 Responsibility: Monetary Policy Committee (MPC) 34 MPC consists of 7 members (of which 4 are from outside) MPC meets 8 times a year with pre-announced schedule Assess recent economic conditions and outlook Set the direction of monetary policy Approve the Inflation Report

35 Policy formulation process 35 Data 3 senior officials from BOT and 4 external members MPC meets 8 times a year Policy rate decision Forecast of output growth and inflation Press release Policy implementation Inflation Report

36 Communications policy: Inflation Report 36 Clear monetary policy stance MPC press conference after each meeting Quarterly Inflation Report Monetary policy information dissemination through: Publications Public symposiums and workshops Visits to educational and financial institutions

37 Inflation Report

38 III. Challenges ahead 38

39 Challenges ahead 39 Choice of policy target Exchange rate management under IT

40 Divergence between core and headline inflation seems to be persist 40 %YoY Headline Inflation Mar Core Inflation

41 41 Difference between headline and core inflation Core inflation excludes prices of raw food and energy. However, it includes the effect of pass-through from these components to other foods and transportation. Composition of Headline Raw food (15.00%*) Energy (9.05%*) Core (75.95%*) Pass-through Pass-through Composition of Core Other foods e.g. cooked food Apparel and footwear Housing and furnishing Medical and personal care Transportation and communication Recreation and education Tobacco and Alcohol * Weight as of base year These shares have changed since. They are now 19.68, and for raw food, energy and core, respectively.

42 Development of inflation: Adoption of IT (May 2000) to present 42 Before IT: Average of core is close to average of headline. However, core is less volatile, making it a better candidate in reflecting underlying inflationary pressure. Percent Mean Before IT 1986 Q Q1 Headline Core After IT 2000 Q Q1 Headline Core After IT: Prolonged Divergence Volatility (S.D.) Energy and raw food prices are no longer temporary supply shocks. Changes in the demand and supply structures of these commodities are persistent. Nature of shocks are different. %YoY Core Headline Upper Target for core inflation Q2 2001Q3 2002Q4 2004Q1 2005Q2 2006Q3 2007Q4

43 Trend of energy and raw food are different from that of core 43 24m moving Index (2000M5=100) CORECPI CPI ENERGY 180 CPI RAWFOOD Start IT 1986M M M M M M12 Difference in trends especially after 2003 onwards implies that exclusion of energy and raw food results in loss of information on underlying trend A prolonged break down in the relationship between headline and core inflation that would persist for some time to come. 2 5 Headline and Core Pre- IT (1986M1 2000M4). 6 Headline and Core Post- IT (2000M5 2007M12) Density Density Bumps caused by oil control during H C P I_ P R E IT K e rn e l C O R E _ P R E IT K e rn e l H C P I_ P O S TI T K e rn e l C O R E _ P O S TIT K e rn e l

44 Structural change in the demand and supply of oil implies that price could rise further 44 Change in Demand Change in Supply High demand with limited production capacity of biofuel Increases in investment in commodities Supply less sensitive to price OPEC continues to dominate market Lower ability to absorb shocks Higher probability of shocks Geopolitics Weather Investor Speculation Oil price likely to rise Higher volatility More likely to overshoot and remain high

45 In the same spirit, raw food prices could also rise further 45 Change in Demand Change in Supply Higher demand from China and India Bio-fuel production Limited capacity to increase supply Low and declining ratio of stock to use Lower ability to absorb shocks Higher probability of shocks due to global warming Raw food prices likely to rise further

46 What next for Thailand? 46 Given the above analysis, it is clear that raw food and energy would play a more significant role in driving inflation dynamics, going forward. It is also clear that other IT countries have moved away from core inflation. Therefore, core or headline??

47 Main considerations for monetary policy in Thailand at present under the inflation targeting framework: 47 The BOT s inflation targeting framework has meant that domestic price stability remains the number one priority for monetary policy At the same time, in the context of increased financial flows into the region, the BOT s has to prevent excessive exchange rate volatility The BOT has prevented volatile capital inflows from disrupting the domestic economy through sterilized intervention to prevent excessive appreciation of the exchange rate restrictions on speculative capital inflows (of various degrees) liberalization of capital outflows to allow more balanced financial flows

48 Considerations in managing the exchange rate 48 Short-term Authorities can intervene to slowdown rapid changes in the exchange rate, providing time for the real sector to adjust Prolonged intervention would prevent the exchange rate from acting as an automatic stabilizer for the economy Longer-term Prolonged intervention is unable to keep the real exchange rate undervalued in the longer-term, as the market will lead to an adjustment in prices, namely the nominal exchange rate

49 The BOT s exchange rate management 49 The exchange rate is allowed to move in accordance with market forces, under the following conditions: The level of FX volatility does not disrupt the real economy The exchange rate helps maintain competitiveness, as measured by the Nominal effective exchange rate (NEER), which takes into account currencies of major trading partners and competitors, using third market weights (and not just the bilateral THB/USD exchange rate) The exchange rate is in line with economic fundamentals, as it could otherwise lead to the buildup of imbalances

50 The Impossible Trinity 50 FX Stability π - Gap Y - Gap Capital Mobiliity Interest rates (i) autonomy Challenges to monetary policy are fundamentally stemmed from the impossible trinity framework as there are limitations to maintain policy objectives given different economic settings

51 Financial imbalances 51 Financial balances in 7 areas are also monitored to safeguard economic and financial stabilities External sector Household sector Corporate sector Financial institutions Financial markets Real estate sector Fiscal sector