By SARAN KITVASIN
Supavud is one of a number of economists who are not convinced by the Bank of Thailand’s insistence that inflation targeting is now the best tool for controlling consumer prices, due to the Kingdom’s larger import-export account.
“If we acknowledge that Thailand’s prices are based on global prices ... [and] if Thailand’s inflation is to be in line with global inflation and if Thailand’s interest rates should be in line with global rates, exchange-rate targeting would then be the best tool for controlling inflation,” he said.
According to a paper by Sarwat Jahan, an economist in the International Monetary Fund’s Strategy, Policy and Review Department, inflation targeting has been successfully practised in a growing number of countries over the past 20 years, and many more countries are moving toward this framework.
His paper states that many central banks began targeting the growth of money supply in order to control inflation. This approach works if the central bank can control the money supply reasonably well and if money growth is stably related to inflation over time.
Ultimately, however, monetary targeting had limited success because the demand for money became unstable, often because of innovations in the financial markets, he said.
As a result, many countries with flexible exchange rates began to target inflation more directly, based on their understanding of the links or “transmission mechanism” from the central bank’s policy instruments, such as interest rates, to inflation.
Jahan noted that, “Over time, inflation targeting has proven to be a flexible framework that has been resilient in changing circumstances, including during the recent global financial crisis. Individual countries, however, must assess their economies to determine whether inflation targeting is appropriate for them or if it can be tailored to suit their needs.
“For example, in many open economies, the exchange rate plays a pivotal role in stabilising output and inflation. In such countries, policy-makers must debate the appropriate role of the exchange rate and whether it should be subordinated to the inflation objective.”
Supavud believes that monetary policy under inflation targeting will face greater challenges as the Thai economy is more exposed to the global economy.
“Not that inflation targeting is bad. But this guideline is based on the assumption that the economy is closed. But in an open economy, would a rate cut keep inflation under control? As a small and open-economy country, our inflation is determined by external factors. As such, if we want to keep inflation under control, the exchange rate should be the focus of our monetary policy,” he said.
Thailand produces 20 million tonnes of rice per year, he said, half of which is exported under prices determined by global buyers. In addition, though the Kingdom is a net auto exporter, prices are determined by global demand and supply.
In this scenario, local prices are subjected to global movements. A higher Thai exchange rate would attract more capital inflows, which would force the Bank of Thailand to encourage more overseas investment, he argued.
Supavud said that New Zealand, where inflation targeting originated, had been successful in this area probably due to the country’s small population of only 3 million and its rather closed economy. Its import-export account contributes only 70-80 per cent of gross domestic product – against 140 per cent in Thailand.
“Since adoption of the policy in 1987, New Zealand’s import-export ratio has been steady. Thailand’s has been on the rise. In time, we will need to ask ourselves if inflation targeting is workable,” he said.
While acknowledging that Singapore also suffers from high inflation despite adopting exchange-rate targeting, the economist said that if local rates were to be lowered to match global rates, the central bank could launch macro-prudential policies to control inflation – like a limit of the level of loan extension to a particular industry.
Supavud said he also favoured a public debate on the issue.