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A fierce debate is going on within Thailand right now as to whether the Bank of Thailand should raise interest rates in order to put a check on inflation.  Coming out strongly against the interest-rate rise are such economists as Dr Olarn Chaipravat, the adviser to the Fiscal Policy Research Institute, conservative economist Dr Virabongsa Ramangkura, former Bank of Thailand governor Vijit Supinit, and Dr Ampon Kittiampon of the National Economic and Social Development Board. Minister Surapong Suebwonglee is also inclined toward supporting this view against higher interest rates.

Opponents of a rate rise believe that inflation is now largely driven by higher fuel prices. This has resulted in cost-push inflation. Economic indicators are showing that demand is weakening, which means that demand has little to do with inflationary pressure. Tightening the monetary policy will do little to tame inflation but it will dampen economic growth, cut jobs and hurt small businesses the most.

But the central bank's main task is to safeguard price stability. It is now in panic mode following a jump in June inflation to 8.9 per cent. It has issued some hawkish statements, warning that inflation would enter into double-digits in coming months. This implies that on July 16 the central bank's Monetary Policy Committee would be obliged to raise its policy rate from the current 3.25 per cent.

Several research houses have started to adjust their forecasts for Thai inflation upward. DBS Research Group, for instance, has raised its 2008 Thai inflation forecast to 8 per cent from 6.4 per cent earlier. This forecast assumes that crude oil prices stop rising from present levels. A continued rise in oil prices would not only jeopardise these inflation forecasts; it would also hurt domestic demand. DBS Research Group expects the central bank to raise interest rates by 50 basis points to 3.75 per cent altogether in the third quarter of this year before hiking the rate by another 25 basis points to bring the policy rate to 4 per cent by the end of 2008.

There is also a possibility that the central bank might raise the policy rate by 50 basis points on July 16, judging from its tough rhetoric.

 The central bank's policy-makers now have an unenviable task. There are decisions to make as there are risks to both inflation and growth, risks which are difficult to quantify because there are so many uncertainties over vital matters such as how bad the G3 economies [US,Japan,EU] will fare and whether oil prices will increase further or fall. However, in this context it is critical to a country's well-being that monetary policy-makers be allowed to make their decisions without political interference. If the best among a menu of bad policy options is to raise interest rates, then central banks should be allowed to do so.

Experience in some other countries backs this. If political leaders had allowed India's central bank (a very respected one) to raise rates as it wanted to some years ago, inflation in India would not have become the headache it has. In fact, this resulting higher inflation has come back to haunt political leaders - high inflation has upset everyone and re-election for the current government seems difficult. Similarly, China found many plausible reasons to tighten its monetary policy in baby steps - now it has a major inflation problem and it is running out of policy tools.

Should policy-makers desist from raising rates because inflation is due to supply shocks and not overheating? The trouble is that core inflation has surged sharply in recent months, so it is hard to argue that it is only a matter of supply shocks. Moreover, even if there have been supply shocks, it is important to prevent the initial rise in inflation from leading to further rises as wages and prices chase each other up - tighter monetary policy would help prevent these second round effects.

Others argue that raising rates is not the way to tackle inflation, that administrative measures such as reserve requirement increases could do the trick. There is definitely a good case to be made for complementing monetary policy with administrative measures or micro-prudential measures (such as restrictions on lending to real estate etc). Such complementary measures can help balance the impact of tighter money.

However, administrative measures cannot substitute for appropriate policy-tightening. China has found that its dependence on administrative measures such as price controls, caps on lending, reserve requirement increases and so on are causing problems such as shortages and sharp cutbacks in activity in some areas and is being forced to reverse some of these measures. We need to learn lessons from this experience.