Thai monetary policy transmission in an inflation targeting era

Transcription

1 Journal of Asian Economics 18 (2007) Thai monetary policy transmission in an inflation targeting era June Charoenseang, Pornkamol Manakit * Faculty of Economics, Chulalongkorn University, Bangkok 10330, Thailand Received 15 September 2006; received in revised form 9 October 2006; accepted 21 November 2006 Abstract A critical issue involved with the transmission of monetary policy is the degree and speed at which changes in the official policy rate are transmitted to other rates faced by firms and households. The paper explores changing financial environment in Thailand after inflation targeting has adopted. Furthermore, the empirical analyses are provided to investigate the long-run relationship and the degree of pass-through between the policy rate and the various financial market interest rates in Thailand. It is found that there exist co-movements between 14-day repurchase rate and the financial market rates in the long-run, except for the finance company lending rate. The paper also shows that the transmission of monetary policy through the interest rate channel has become weak. Nonetheless, the credit channel through the commercial bank lending is still a valid monetary transmission mechanism of Thailand. It is worth noting that there is a decrease in the degree of disintermediation as well as an increase in the roles of other sources of fund. # 2007 Elsevier Inc. All rights reserved. JEL classification : E42; E52; E58 Keywords: Transmission of monetary policy; Interest rate pass-through; Asymmetric adjustment 1. Introduction It is commonly known that monetary authorities around the globe alter their policy instruments at their disposal in an attempt to achieve their ultimate objectives such as price stability and sustainable economic growth. These processes involve the transmission mechanism of monetary policy. Most central banks normally use a short-term interest rate as their main instrument of monetary policy. There is a presumption that the official rate changes will influence the other short-term rates set by other banks and financial institutions; as changes in the official * Corresponding author. Tel.: ; fax: address: Pornkamol.M@chula.ac.th (P. Manakit) /$ see front matter # 2007 Elsevier Inc. All rights reserved. doi: /j.asieco

2 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) rate are the first step in the transmission of monetary policy. Hence, consumption and investment decisions by households and firms will be led by changes in interest rates charged by banks and other financial institutions. Therefore, effect of monetary policy will be substantial, if official rate changes could be completely passed-through to other interest rates in the market over a reasonably short period of time. In other words, a critical issue involved with the transmission of monetary policy is the degree and speed at which changes in the official policy rate are transmitted to other rates faced by firms and households. In practice, the transmission mechanism of monetary policy is usually sluggish and incomplete in the short run; therefore, changes in the policy rate induced by monetary policy are transmitted to other interest rates with lag. Consequently, interest rate differentials exist in the economy. This paper aims at answering these following four questions: (1) What have happened in Thailand in term of financial environment after adopting inflation targeting? (2) To what extent are changes in the 14-day repurchase rate passed-through to various retail deposit and lending rates? (3) What are speeds at which changes in the policy rate transmitted to deposit and lending rates? And (4) How does monetary policy transmit its effect through credit and interest rate channels after inflation targeting has been adopted? This paper is structured as follows. Section 2 describes details on background of monetary policy in Thailand. Section 3 shows empirical testing of the relationship between monetary policy and interest rates, degree of pass-through and asymmetric adjustment as well. Section 4 employs vector-autoregression models to estimate monetary policy transmission in Thailand. Section 5 reflects our conclusion remark. 2. Background on monetary policy in Thailand 2.1. Monetary policy framework The monetary policy framework in Thailand can be divided into three periods as follows. The first 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 flow has been allowed; a monetary policy regime with fixed exchange rate became one factor that led the country to an excessive external borrowing and financial instability afterwards. After letting the baht float 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 financial 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 financial system. Later on, when Thailand had exited the IMF program; the Bank of Thailand formally adopted inflation targeting in May 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 inflation targeting, the Bank implements its monetary policy by influencing 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

3 146 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) of change in the key policy rate. The inflation targeting allows Thai monetary policy to be able to cope with shocks in the domestic economy without relying on a relationship between money and inflation. Moreover, as a range of inflation 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 inflation targeting provides a commitment to the public. Thus, economic agents could incorporate information on inflation 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 inflation targeting framework, when there is an increasing in an aggregate demand which eventually influences general price level; the monetary authority would tighten a monetary policy. Consequently, inflationary pressure would be subdued. The Bank of Thailand conducts open market operations by undertaking transactions in financial 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. The Bank has the option of conducting either fixed-rate or variable-rate tenders. However, to enhance the signaling effect of the policy as well as committing to its announcement; a fixed-rate tender is always conducted for the 14-day tenor whereas a variable-rate applies for all other tenors. Therefore, bilateral primary dealers will indicate the amounts of money they wish to transact with the Bank at the policy rate while these bilateral primary dealers will indicate the amounts and the interest rates at which they want to transact with the Bank in a variable-rate tender What has happened since inflation targeting is adopted Inflation targeting had adopted since May The core inflation was 0.84% in quarter 3 and declined further to 0.76% in the last quarter of In fact, since inflation targeting has adopted; the core inflation appeared to be well contained within the policy target of 0 3.5%. Next, we shall look at a changing financial environment after inflation targeting has been adopted At the end of 2000, private commercial banks operation continued to improve compared to Despite the performance of small and medium-sized banks improved marginally; large private Thai commercial banks had net after tax profit in the last half of However, commercial banks as a whole recorded a net before tax loss of billion baht and thus recorded a net after tax loss of 70.2 billion baht (Table 1). The decline in non-performing loans was quite sluggish, the NPL ratio decreased to 17.9% at the end of the year In 2001, the government established Thai Asset Management Corporation (TAMC) to buy out non-performing assets from financial institutions. Excess liquidity conditions in the financial system remained because of deposit expansion coupled with low new loan approval. Nonetheless, total commercial bank deposit outstanding grew at a decreasing rate because of economic slowdown. Consequently, in December, the Bank of Thailand introduced various measures to help removing obstacles to credit extension. These measures were expected to help promoting long-term credit growth. Meanwhile liquidity in the money market continued to be high as growth of deposit exceeded that of lending. Consequently, 3-month deposit rate and minimum lending rate (MLR) were reduced to 2.25 and , respectively. In an early June,

4 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Table 1 Profit and loss of commercial banks Unit: billion baht All commercial banks Profit/loss from operations Loan loss provision Net profit/loss before tax Thai commercial banks Profit/loss from operations Loan loss provision Net profit/loss before tax Foreign commercial bank branches Profit/loss from operations Loan loss provision Net profit/loss before tax Source: Bank of Thailand. the Bank of Thailand also increased the 14-day repurchase rate from 1.5% to 2.5% in an attempt to correct the distorted structure of local short-term interest rates and restore external stability. As a result, there was an overall improvement in the balance of payments while there was an increase in international reserves and Baht was stabilized as well. After the attempt above was achieved; the Bank lowered the 14-day repurchase rate from 2.5% to 2.25% in late December. This declining rate was consistent to that of the world rate trend. The consumer price index (CPI) remained low throughout the year 2001 due to weak domestic demand that coupled with lower oil price. Liquidity in the financial system remained high even though there was an issuance of government saving bonds totaled to 305 Billion Baht. So, the short-term money market interest rates were kept low in line with several policy rate cuts. As a matter of fact, commercial banks cut both deposit and lending rates at the beginning of the year and once again around the end of the year. The average 3-month fixed deposit rate fell from 2.25% per year in December 2001 to 1.75% a year later. Simultaneously, the average minimum lending rate also fell from 7.125% to 6.69% per year. These low rates helped stimulate private spending and reducing the cost of borrowing for private investment. Personal consumption and housing loans grew positively through the year whereas industrial, export and commercial loans started to expand in late It is worth noting that consumers and investors did not rely solely on financial institutions credits as in the past as they had access to alternative sources of finance such as leasing companies, retained profits or issuance of debentures (Table 2). Domestic spending led by private Table 2 Business Sources of funds (excluding commercial bank credits) Unit: billion baht New issuance of debentures New issuance of equities Foreign direct investment Operating profits Source: Bank of Thailand.

5 148 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) consumption was the main driving force to economic growth in However, headline inflation stayed low at an average of 0.7% while core inflation was equal to 0.4%. Even though demand expanded but there was still excess production capacity thus the rising demand did not lead to higher inflation. The Bank of Thailand s policy rate was cut from 1.75% per year to 1.25% per year in June 2003 while liquidity in the financial system remained persistently high. Therefore, commercial banks interest rates had remained low throughout The low interest rates had continued to boost up private spending; commercial bank credits improved substantially. While commercial bank operations seemed to improve further as well. The Ministry of Finance together with the Bank of Thailand initiated the Financial Sector Master Plan to help enhancing better financial services to small- and medium-sized business as well as to people in the provincial area. Headline inflation was 1.8% while core inflation averaged at 0.2%. Moreover, current account balance continued to be in surplus. Thus, the Bank of Thailand early repaid all obligations under the IMF loan program while international reserves remained at the level that was more than three times that of short-term external debt obligations. Although the Bank of Thailand had raised policy rate three times in 2004; interest rates on deposit and lending remained unchanged due to substantial liquidity in financial sector (Table 3). The excess liquidity of commercial banks increased slightly in quarter 4 of 2004 after the dropping of excess liquidity in quarter 3 as there was an issuance of saving bonds. This increase in excess liquidity was partly attributed to greater need of the FIDF to borrow from the repurchase market in order to redeem the AMC promissory notes. As a result of the redemption, commercial banks invested in the repurchase market which led to a rise in excess liquidity. It is worth noting that most excess liquidity concentrated in the four large private commercial banks. According to the Bank of Thailand Inflation Report January (2005), these four banks accumulated about 70% of total excess liquidity in the systems. Consequently, there was a delayed adjustment in the reference interest rates (Table 4). Thus, commercial bank credit granted to both corporate and household sectors largely expand. Nonetheless, stated-owned commercial banks and medium and small banks had much less excess liquidity. Headline inflation averaged at 2.7% per year while core inflation average at 0.4%. The foreign reserves position was quite strong and remained at the level that was about four times that of short-term external debt obligations. In 2005, short-term money market rates rose as policy rate were raised six times in total, from 2.00% per year to 4.00% per year. Although the transmission of monetary policy to commercial banks reference rates had been slow at first; the increasing policy rates eventually transmitted to financial institutions. Most commercial banks raised their deposit and lending rates in late quarter 2 of 2005 and these rates have continued to rise throughout quarter 4 of 2005 (Fig. 1). Commercial banks have Table 3 Commercial bank deposits and private credits a Unit: billion bath Claims on private sectors b Deposits Source: Bank of Thailand. a Including Thanachart Bank since April b Including investment in private and adding back debt write-offs and loans transferred to AMCs but excluding credit extended to AMCs.

6 Table 4 Commercial bank interest rates a J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Percent per annum Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 12-Month deposit rate Average of 4 large commercial banks Average of other commercial banks b MLR Average of 4 large commercial banks Average of other commercial banks b c Source: Bank of Thailand. a At end quarter. b Thai commercial banks only, including banks which are upgraded in accordance with the One Presence policy but excluding retail banks. c The average MLR declined due to the reduction in the number of commercial banks in September also offered complicated deposit-type products to retain their depositors. This did not only reflect a clearer transmission mechanism but it also reflected a more intense competition among commercial banks as well as competition from other investment alternatives. In addition, there was an expansion of commercial banks private deposits and claims on the private credits and commercial banks holding of private-sector securities as a result of One Presence policy. This Fig. 1. Thailand interest rates Source: Bank of Thailand.

7 150 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) policy had led finance companies to merge and upgrade to commercial bank status. Moreover, the market share of the four large banks had been falling since the middle of 2005 while the shares of small- and medium-sized banks and of foreign bank branches had been rising. Headline inflation averaged at 4.5% per year whereas core inflation remained at 1.6%. International reserves remained high while the level of external debt obligation declined steadily. The above information gives a general overview of Thai financial environment after inflation targeting has been adopted. Next, it is interesting to explore at what extent can monetary authorities influence the level of economic activity in Thailand? Because the effectiveness of monetary policy depends critically on the transmission of a policy to output and thus inflation. There is a study by Disyatat and Vongsinsirikul (2002) which investigated how the Thai economy had responded with tightening monetary policy. Their main findings are as follows. The general price level initially response marginally; nonetheless, price started to drop after about a year and quite persistently so. Furthermore, they found that output had a U-shape response to a tightening monetary policy; the turning point was around 4 5 quarters and eventually dissipated after around 11 quarter. In addition, they also found that investment was the most sensitive component of gross domestic product to monetary policy shock. In general, Disyatat and Vongsinsirikul (2002) found that interest rate pass-through in Thailand was also found to be generally lower than those in developed countries. They stated that banks played an important role in a transmission mechanism while the exchange rate and the asset price channels had been less significance compared to that of bank lending channels. However, the role of bank lending had appeared to be lesser during As investment demand had been quite low coupled with excess capacity and balance sheet weaknesses in the corporate sector. As time has passed, it is crucial to start investigating how the transmission has been changed after the new monetary policy framework was adopted. According to the data the pass-through from policy rates to retail rates of commercial banks was sluggish until the later part of Therefore, the following sections are devoted to econometric testing which will help answering our proposed questions stated earlier. 3. Interest rates and monetary policy This section aims at analyzing the relationship between monetary policy and selected interest rates during June 2000 to July 2006 which covers the period after the Bank of Thailand adopted the inflation targeting framework. The long- and short-run dynamic relationships of financial market interest rates and the Bank of Thailand policy rate (14-day repurchase rate) are examined employing Engle-Granger (1987) Cointegration and error-correction procedures. Furthermore, the asymmetric short-run dynamic equations are also estimated. The study employs monthly series of interest rate data for selected banks and finance companies interest rates in Thailand. First the long-run relationship and the degree of pass-through effect can be estimated from the following equation: i t ¼ a 0 þ a 1 RP14 t þ e t (1) where i t represents the lending or deposit rates, RP14 t represent the 14-day repurchase market rate which is the Bank of Thailand monetary policy indicator, e t is the disturbance term, a 0 and a 1 are the model parameters. The long-run adjustment is complete when a 1 is equal to one and is incomplete when a 1 is less than one. a 0 measures the constant markup.

8 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) In order to examine the short-run dynamics of the financial market interest rates to changes in the 14-day repurchase rate, the concept of error-correction procedure is applied Di t ¼ b 0 þ b 1 DRP14 t þ b 2 e t 1 þ e t (2) where D denotes first difference and e t denotes the error term. e t 1 = i t 1 a 0 a 1 RP14 t 1 captures the disequilibrium at time t 1. b 2 represents the error correction adjustment speed when the rates are away from their equilibrium level and is expected to be negative. The mean adjustment lag of a complete pass-through can be calculated by (1 b 1 )/b 2. As suggested by Chong, Lui, and Shrestha (2006), the adjustment speed of the interest rate may differ when they are below or above the long-run equilibrium. Therefore, in order to test for the asymmetric adjustments in the financial market interest rates when they are above or below their equilibrium levels; the dummy variable (d) is employed. The asymmetric short-run dynamic equations can be specified as Di t ¼ u 0 þ u 1 DRP14 t þ u 2 d t 1 e t 1 þ u 3 ð1 d t 1 Þe t 1 þ e t (3) where d t 1 = 1 if the residual, e t 1 is positive and 0 otherwise. To detect the presence of asymmetric adjustment, the standard Wald test is then employed. For commercial banks, the referenced lending rates are the minimum loan rate and the minimum retail rate. The referenced deposit rates are the savings deposit rate (SD), the average 3 6 months time deposit rate (TD3-6), and the average 6 12 months time deposit rate (TD6-12). For finance companies, the referenced rates are average lending rate (FCL), the borrowing rate at call (FCB), and the average 12-month borrowing rate (FCB12). The empirical results can be summarized as follows. In order to investigate the long-run relationship between the repurchase rate and the other financial market interest rates, Eq. (1) is estimated and shown in Table 5. The estimated results for most cases show that there exist comovements between 14-day repurchase rate and the financial market rates in the long-run, except for the finance company lending rate. The residual unit root tests provided by Augmented Dickey Fuller and Phillips-Perron fail to accept the null hypothesis of unit root (no cointegration) at the 5% level of significance. However, for the finance companies lending rate, both tests show that the null hypothesis of no cointegration cannot be rejected. The relationship between interbank and 14-day repurchase rate is also examined. The results indicate that there pass-through is almost complete, that is about 96.3%. Table 5 Long-run relationship and the degree of pass-through Markup (a 0 ) Degree of pass-through ADF-test p-value Phillips-Perron test p-value IB MLR MRR SD TD TD FCB FCB FCL * Note: Augmented-Dickey Fuller and Phillips-Perron tests are applied to the regression residuals. * Indicates that the null hypothesis of unit root cannot be rejected at the 5% level of significance.

9 152 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Table 6 Short-run dynamics: Di t = b 0 + b 1 DRP14 t + b 2 e t 1 + e t b 1 p-value b 2 p-value Mean adjustment lags IB MLR MRR SD TD TD FCB FCB For commercial banks, the markup for loan rate is higher than that of deposit rate. The markup for minimum loan rate and minimum retail rate are 6.14% and 6.49%, respectively. However, the markup for deposit rates is only for the saving deposit and about 0.8 for the time deposit. Also, all slope coefficients indicate incomplete pass-through effect. The pass-through for loan rates is only 26.5% on average. On the deposit side, the pass-through effect is larger for the longterm saving rate, which is more then 50%. However, the pass-through effect for saving deposit rate is 21.9%. For the finance companies, there is no co-movement between the 14-repurchase market rate and the finance companies lending rate. The mark up for the long-term borrowing rate is higher than that of the commercial banks rates. This is probably because finance companies have to compete more for saving deposits. However, the pass-through rate on finance companies deposit rate is smaller than that of commercial banks. Next, the short-run dynamic analysis is provided by the error-correction model. The results are provided in Table 6. All the estimates of b 2 are found to be negative and statistically significant which implies that the interest rates are mean-reverting to long-run equilibrium. That is, the rates will adjust upwards when they are below the equilibrium level and adjust downwards when the rates are above their equilibrium levels. However, the adjustment speeds are different. For commercial banks, the results indicate that the adjustment speed is slower for the lending rates which take about 15 months. The saving deposit rate takes about 12 months and the time deposit rates take, on average, about 7.5 months. For the finance companies, the long-term borrowing rate, however, take about 4 months longer adjustment period. On the other hand, the interbank rate adjusts almost immediately with the change in the 14-day repurchase market rate, that is, within a month. The results for the asymmetric adjustment as from Eq. (3) are reported in Table 7. Comparing the coefficients u 2 and u 3, Wald test statistics show that the coefficients are not statistically different from each other. In other words, there is no significant asymmetric adjustment for these interest rates with respect to the RP14 rate. However, there is one interesting point from the results. That is, for most of the cases, the short-term borrowing rates for both commercial banks and finance companies tend to spend more time in adjusting downwards comparing when they are adjusting upwards. On the other hand, the commercial bank lending rates tend to spend less time in adjusting downward and spend more time in adjusting upward. The results may reflect that the degree of disintermediation and the role of non-bank financing may increase the elasticity of deposit supply and loan demand during the period of the study. In summary, the empirical results in this section show that there is only small pass-through effect from the central bank policy rate to the financial market interest rates. In addition, on

10 Table 7 The test for asymmetric adjustment (Di t = u 0 + u 1 DRP14 t + u 2 de t 1 + u 3 (1 d)e t 1 + e t ) u 1 p-value u 2 p-value MAL+ u 3 p-value MAL Adj R 2 Wald p-value MLR MRR SD TD TD FCB FCB FCL IB Notes: (1) MAL+ is the mean adjustment lag when residual is positive and MAL is the mean adjustment lag when residual is negative. (2) Wald test: null hypothesis is u 2 = u 3. J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007)

11 154 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Fig. 2. The interest rate channel: private investment and minimum lending rate. average, the commercial bank lending rates tend to adjust lower than the deposit rates. With the asymmetric adjustment analysis, the lending rates take more time in adjusting upwards, comparing with those deposit rates. Moreover, there is no long-run relationship between the finance companies lending rate and the central bank policy rate. However, there is interbank market rate takes the effect from the adjustment in the repurchase market at the same period of time with the pass-through effect more than 96%. Therefore, the next section provides the test of transmission mechanism of monetary policy in Thailand to investigate whether the interest rate channel is still important after the inflation targeting framework has adopted or not. 4. Transmission mechanism of the monetary policy There are 2 major channels of monetary policy transmission in Thailand, namely, the interest channel and the bank credit rate channel (Disyatat & Vongsinsirikul, 2002). The period of study covers June 2000 to July 2006, the period after the inflation targeting framework has adopted. In this section the impulse response functions are examined for interest rate and bank credit

12 channels. Number of lags included in the model is determined by the Akaike Information Criteria. The 14-day repurchase rate (RP) represents the monetary policy indicator and the private investment index is a proxy of economics activity The interest rate channel J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Under the interest rate channel, the expansionary monetary policy influences the economic activities through interest rates. Taylor (1995) argues that financial market prices are key components of how monetary policy affects real activities. In his model, an expansionary monetary policy reduces short-term interest rates. Since prices and wages are assumed to be rigid, real long-term interest rates decrease as well. These lower real long-term rates lead to an increase in real investment and thereby on real income. The two vector-autoregression models are estimated. Each model includes RP14, interest rate, economic indicator, and core inflation rate (CINF). The estimated impulses are shown in Figs. 2 and 3. The first model focuses on investment activity (Fig. 2). Thus, minimum lending rate (MLR) and private investment index (PII) are included as interest rate and economic activity, respectively. The plotting results illustrate that there is no strong support for the interest rate Fig. 3. The interest rate channel: private consumption index and minimum retail rate.

13 156 J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) channel. The 14-day repurchase rate does not strongly influence the minimum lending rate. In the mean time, a shock to the minimum lending rate leads to a gradually decreasing in private investment. This effect is significant for about months. From this model, we also observe that the change in the 14-day repurchase rate is based on the past values of core inflation. In addition, the negative response of core inflation to increasing in the 14-day repurchase rate is found. The second model includes minimum retail rate and private consumption index in the model (Fig. 3). Similar to the first model, the effect of a shock on 14-day repurchase rate on minimum retail rate is not statistically significant. However, there exists a negative significant impact of a shock in minimum retail rate on private consumption. The responses of core inflation rate between the 14-day repurchase rates are consistent with the results obtained from the previous model The credit channel The relevance of the credit channel examines the co-movements in the stance of monetary policy, bank loans, and economic activity. According to this view, commercial banks play a special role in the financial system because they are especially well suited to deal with certain Fig. 4. The credit channel.

14 types of borrowers, specifically small and medium firms (Bernanke & Blinder, 1992). This has still been the characteristics for the financial system in Thailand after the economic crisis in The decreasing in the supply of loans, therefore, is more likely to increase the cost of funds and reduce real economic activity. The vector-autoregression model includes the 14-day repurchase rate (RP), commercial bank credit to private sector (LEND), private investment index (PII), and core inflation rate (CINF). The estimated impulses are shown in Fig. 4. The impulse responses indicate that a shock to the 14-day repurchase rate significantly reduce commercial banks credit to private sector for about 4 months. However, the impulse responses from a shock in lending have no impact on RP14. In addition, commercial bank lending also stimulates private investment during the period of study. When looking at the relationship between RP14 and core inflation rate, the findings show that the high inflation rates lead to increasing in RP14 rate. On the other hand, when the Bank of Thailand increases RP14 rate, it gradually reduces the core inflation rate which indicates the success control of the Bank of Thailand in controlling the core inflation. 5. Conclusion The transmission of monetary policy through the interest rate channel has become weak after inflation targeting has been adopted. Even thought the long-run relationship between the policy rate and the money market rates are still observed, the pass-through effect is quite low at about only 20%. On the other hand, the credit channel through the commercial bank lending is still a valid monetary transmission mechanism in Thailand during 2000: :07. The monetary policy significantly affects the commercial bank lending in the short run. Also the commercial banks still play important role in the Thai financial market as the major source of fund. Strong relationship between bank lending and economic activity indicate that there still exist bankdependent borrowers who have limited opportunities to substitute credit from other financial intermediaries but banks. In addition, there still exists a significant relationship between the commercial bank lending rate and the economic activities. References J. Charoenseang, P. Manakit / Journal of Asian Economics 18 (2007) Bank of Thailand. (2005, January). Inflation Report, Bernanke, B. S., & Blinder, A. S. (1992). The federal funds rate and the channels of monetary transmission. American Economic Review, 82(4), Chong, B. S., Liu, M., & Shrestha, K. (2006). Monetary transmission via the administered interest rates channel. Journal of Banking & Finance, 30, Disyatat, P., & Vongsinsirikul, P. (2002). Monetary policy and the transmission mechanism in Thailand. Bank of Thailand 2002 Symposium on the Road to Sustainable Growth: Getting the Fundamental Right. Engle, R. F., & Granger, C. W. J. (1987). Co-integration and error correction: Representation, estimation and testing. Econometrica, 55, Taylor, J. B. (1995). The monetary transmission mechanism: An empirical framework. Journal of Economic Perspective, 9(4),