Fiscal stimulus measures to fuel inflation

Such is the finding of a new study by the Bank of Thailand (BOT).

"The output gap in the second quarter is near zero, indicating pres¬sure on prices caused by intense resource use," BOT economists led by Don Nakornthab said in a paper pre¬sented yesterday at the central bank's annual symposium.

Notably, the conclusion that the economy has no more room for growth flies against other schools of thought, including that of the gov¬ernment, which sees a potential growth rate of more than 8 per cent for gross domestic product (GDP). The fiscal authorities want to boost the economy to perform at its max¬imum potential.

The paper, entitled "Uncertainty in the Estimation of Potential Output and Implications for the Conduct of Monetary Policy", said the economy appeared to have grown at its poten¬tial fastest pace in the first quarter.

The economists predict fullout growth will be shown to have con¬tinued in the second quarter, as a result of 5.3percent growth in the economy, compared with potential growth of 5.25.3 per cent in the peri¬od. This would cause resources to be tighter than in the past.

When the output gap - the gap between actual and potential growth - approaches zero, it will lead to a scarcity of production inputs.

"Moreover, the accelerating infla¬tion is spurred by other factors, par¬ticularly inflation expectations," the economists said.

The study found economic growth was 8 per cent before the 1997 economic crisis, higher than its potential level. However, it was 9 per cent in 1998 after the crisis, lower than its potential.

GDP growth that is higher than its potential pushes up prices, because it creates a shortage of pro¬duction resources. In contrast, an economy that is coasting below potential eases inflationary pressure, due to oversupply.

The study, which used an unob¬servedcomponent model, also con¬firmed the economy grew at the country's potential level in this year's first quarter. Before, between late 2006 and last year, GDP was expanding lower than its potential, due to sluggish consumption and investment resulting from the polit¬ical uncertainty.

Studying production functions, the economists found average poten¬tial output growth would range from 5.56.1 per cent between this year and 2015, compared with 5 per cent from 200007, assuming that output and capital increase at the same pace, with strong investment expansion. If investment does not pick up sharply, potential output growth would sink below 5.56.1 per cent.

The economists said the BOT should adhere to a cautionary stance towards monetary policy, in order to maintain price stability via inflation expectations. It should also allow the economy to grow in line with its potential.

Thitithep Sitthiyot, an official with the Public Debt Management Office, said the study should have taken into account the underground economy, which played a crucial role on the official economy.

If the underground economy is big, 5.25.3percent growth may not reflect the country's actual out¬put potential, he said.

The National Economic and Social Development Board reported Thailand's underground economy from 199395 accounted for 813 per cent of GDP. However, Schneider and Enste believe the underground economy was responsible for 70 per cent of GDP in 1998-99.

Thitithep also said if the BOT wanted to douse inflation expecta¬tions, nudging up interest rates would be an appropriate tool as long as the central bank's credibility was sound.