Tight monetary policy needed to fight inflation: BOT

Another study said that aside from interest rate, foreign exchange could also be a monetary tool to fight infla¬tion.

BOT team executive Roong Mallikamas said inflation had a cor¬relation with its persistence.

During expansionary monetary policy, the persistence would be large, and it would be minimal when mon¬etary policy is tightened, according to the study entitled "Inflation Dynamics and Implications on Monetary Policy".

"If monetary policy is not tight dur¬ing high inflation, the impact of sup¬ply shocks on the inflation would con¬tinue even after the supply shocks cease," Roong said.

The supply shocks had only a tem¬porary effect on the country's inflation, if they were encouraged by other fac¬tors, such as a tooeasy monetary pol¬icy.

Oil and commodity price dynam¬ic has changed over the past five years, resulting in higher oil and commod¬ity prices  the cause of the current inflation  to persist.

Porametee Vimolsiri, senior advis¬er of the National Economic and Social Development Board (NESDB) said the central bank should empha¬sise not only inflation expectation but also output expectation, with which most people are concerned.

"Gross domestic product is like Cinderella that the three sisters defame and damage," he said.

Moreover, he said the central bank did not need to have an aggressive monetary policy because commercial banks, which adopted the Basel II standard, would bring about the forthcoming monetary policy with careful lending.

He also recommended that the central bank raise its inflation target range from 3.5 per cent at present to lower the BOT's burden. All countries have to stay at higher inflation levels over the next 45 years in comparison with what they were used to in the past.

In the paper entitled "Roles of Exchange Rate in Monetary Policy under Inflation Targeting: A Case Study for Thailand", the BOT econo¬mists said foreign exchange could be an additional tool in the inflation tar¬geting framework because it could foster inflation and inflation expecta¬tion.

The policy interest rate had limit¬ed effectiveness on the exchange rate. The central bank, however, could use the foreign exchange directly to han¬dle inflation, according to the study led by Chayawadee Chaianant.

Just one per cent of the appreciat¬ing baht would bring down inflation by about 0.13 per cent and 0.20 per cent of inflation of imported goods.

She said the foreign exchange would be effective only in cases when the inflation risk was temporary and had an impact on prices of imported goods.

The exchange rate would have a more rapid impact on inflation than interest rate. However, the effect would be shortterm compared with the policy interest rate.

The foreign exchange had a less adverse impact on economic growth than the key interest rate. But it has a  longterm impact compared to inter¬est rate, according to the study.

The more the baht appreciates, the more the inflation would drop rapid¬ly, lowering the need to hike interest rate. The move, however, would have a greater negative impact on economic growth.

The effectiveness of the foreign exchange in tackling inflation would depend on the authority's ability to manage the currency, the BOT econ¬omists said.

"In Thailand, the slowdown in the depreciation of the baht would reduce inflationary pressure spurred by inflation expectation at a certain level," said Chayawadee.