BOT governor points dilemma in dealing with "spillover" impacts
The global connectedness poses a big challenge for central banks in adjusting policies to cope with "spillover" impacts and at the same time preserving monetary policy independence, said Bank of Thailand governor Prasarn Trairatvorakul.
In his opening remark at a 2-day conference co-hosted by Bank of Thailand and the International Monetary Fund, he noted that global liquidity conditions will continue to largely depend on the macroeconomic conditions of reserve-issuing countries like the US and the euro zone. He also implied that these countries should be mindful of the impacts of their actions.
"As the US dollar is used heavily abroad, the effective US dollar currency area extends well beyond US borders. The Federal Reserve sets policy for this wider currency area, not just the 50 US states. There have been a lot of discussions about how policy cooperation and coordination may offer scope for improvement. But a practical solution still seems elusive."
Urging conference participants to brainstorm on possible solutions, he said spillover impacts have posed great challenges to small open countries.
Thailand adopted a multi-dimensional response to the spillovers, he said. Currency appreciation was the main cushion against rising inflows. At times when exchange rate volatility became excessive, some foreign exchange intervention was undertaken while intervention costs and its limited effectiveness were taken into account. Controls on outflows were deregulated. The policy interest rate was raised in response to expanding domestic demand, rising price pressures, and strong credit growth, on the belief that other factors such as the strength of the domestic economy and high risk appetite of international investors, played a larger role in inducing capital inflows than a gradual increase in the policy rate.
Prasarn admitted that things became more challenging as the Thai economy suffered domestic setbacks. Domestic demand slowed down markedly after stimulus measures ended this year, but credit growth was still high while stock prices continued to advance and activity in the housing market remained brisk. Moreover, portfolio capital inflows continued and the baht was appreciating.
"This presented a dilemma and was an example of the difficulties posed by policy spillovers," he said.
Against the backdrop of weak global demand, the policy rate was cut and certain prudential measures were contemplated, including those on capital flows, to complement domestic monetary policy as well as offset some of the impact of capital inflows on domestic financial conditions.
How connected the world is?
Trade in goods and services, as a share of world GDP, increased from around 15 per cent in the early 1980s to around 25 per cent before the start of the crisis in 2007.
This induced a significant increase in financial integration. While the annual growth in world trade over the past 40 years has exceeded the growth in world GDP by around 2.6 per cent on average, growth in international external positions outpaced growth in world GDP by almost double that - around 4.8 percent.