Can monetary policy solve the problems besetting the Thai economy?

Economy July 17, 2014 00:00


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The three problems faced by the Thai economy are a slow growth rate, increasing inflation and a fluctuating exchange rate. On the first point, it has been predicted by many famous institutions such as the Bank of Thailand and the National Institute of Dev

In general, there are two main policies involving the economy, which are fiscal policy and monetary policy. Fiscal policy is used by government and monetary policy is used by the central bank. The way each policy is used will have different effects on the economy. Therefore, it is important for business to analyse which policy will be used in what way.

Given the situation in Thailand, it is better that we not talk about fiscal policy. Here, we will analyse how monetary policy can be used to deal with the three problems mentioned above. The main question is which problems the monetary policy should focus on.

Monetary policy vs GDP

According to economic theory, in order to stimulate the economy, the Bank of Thailand has to increase the money supply, which will cause market interest rates to decrease, leading to increased investment and finally GDP growth. Therefore the effectiveness of monetary policy depends on 1) whether increasing the money supply has an effect on interest rates and 2) the response of investors to interest rates.

With the political situation in Thailand, investors consider political risk as the main factor, so the decisions they make do not depend on interest rates as much as in the past. As a result, investment will not be responsive to interest rates. Moreover, the Thai policy interest rate is already low at about 2 per cent. This means decreasing the policy rate would have little effect on money supply, and consequently little effect on market interest rates. Therefore, to use monetary policy to stimulate economic growth in this situation will not be optimal.

Monetary policy vs inflation

Monetary policy can reduce inflation by reducing the demand for goods and services. In the Thai economy, inflation is caused by increasing energy prices and wages, which is supply-side. That means prices are increased because of costs increasing. Inflation caused by cost-push will lead to an increase in prices and decrease in GDP. Reducing inflation by monetary policy is done by decreasing the money supply, so interest rates will rise and investment will decline.

Monetary policy vs exchange rate

Because of global trends such as technology and the regulatory openness of each country, the linkage between each economy is stronger and faster. Change in one economy, especially a big economy, will affect others faster and to a higher degree. Therefore, the effect on the exchange rate from such changes will be greater and quicker.

Appreciation or depreciation of a currency can have both good and bad effects on the economy. For example, many people may think that devaluing the currency is good for an economy because the country can export more. But devaluation can also cause inflation, so everyone in the economy will be hurt. Moreover, the quick response can create variations in the exchange rate, which implies more risk for international firms. Therefore, we must keep the exchange rate at the optimal level and decrease its variation.

Another role of the Bank of Thailand is to control the exchange rate. Since developed countries such as those in North America and Europe and Japan attempt to use monetary policy to help their economies, the world’s money quantity fluctuates, creating speculation across regions. So exchange-rate movement does not represent the economy, which will follow the speculation. The exchange rate will fluctuate a lot. This means the Bank of Thailand should focus on what the optimal exchange rate is for the Thai economy and reduce the fluctuation of the baht.

In conclusion, monetary policy has less effectiveness on stimulating growth than fiscal policy. Fluctuation of the exchange rate can become a problem for the economy. There are some links between inflation and exchange rates, but inflation should not be the target of the Bank of Thailand. Therefore, monetary policy should target an appropriate exchange rate while reducing exchange-rate variation.

Wisit Chaisrisawatsuk PhD is an assistant professor at the Graduate School of Development Economics, National Institute of Development Administration.