Policy target setting
The Bank of Thailand (BoT) has conducted monetary policy under a flexible inflation targeting framework since May 2000. Underthis framework, the BoT pays attention not only to ensuring price stability through setting inflation target (so-called “monetary policy target”), but also to preserving economic growth and financial stability.
Inflation target from May 2000 to December 2008
1) The use of core inflation as monetary policy target
Core inflation is a year-on-year percentage change of consumer price index (CPI) that excludes fresh food and energy prices, which comprise for instance prices of rice, flour, cereal products, meats, vegetables, fruits, electricity, cooking gas, and gasoline. The rationale for such exclusion is that prices of those excludeditems are highly volatile in the short run and tend to be affected by factors beyond the control of monetary policy. Retaining these items in the target measure could, therefore, lead to too frequent changes in monetary policy stance, and maycauseheightened economic volatilities. For example, in the case where prices of fresh food and energy rise, households' purchasing power declines, which negatively affects economic growth.If the central bank decides totighten monetary policy to reduce inflation, the decline in consumption and economic growth can be exacerbated. The exclusion of those prices thus not only helps decrease volatilities of the target measure, but makes it better reflect underlying inflation pressures, particularly those stemmed from the demand side, which can be influenced by monetary policy.
Despite the exclusion of fresh food and energy prices, changes in the general price level can still be reflected in movements of core inflation, sincegoods and services that remain in the calculation of core inflation account for roughly three-fourths of the consumption basket. In addition, historical data shows that, despite some deviations in the short run, core inflation closely tracks headline inflation in the long run. Therefore, the maintenance of price stability through targeting core inflation will eventually lead to overall price stability in the long run.
2) Setting the target range for core inflation at 0-3.5 percent, by considering:
(1) The ability of people from various groups in the economy to adjust to changes in the price level, particularly retirees who mainly rely on interest income from savings, fixed-income employees, and labourers who have low wage-bargaining power. Those groups of people may be adversely affected by a too high inflation target, as their income may fail to catch up with inflation, which erodes their purchasing power.
(2) Consistency with prevailed inflation rates of Thailand's major trading partners and competitors. Ensuring that Thailand's inflation rate is in line with that of trading partners and competitors helps preserve export price competitiveness. Over the past 10 years (1999-2008), inflation of those countries averaged at around 1.8 percent.
3) The use of "quarterly-average" core inflation as the target
Given high volatility of monthly inflation figures, averaging core inflation over the quarter allows for better discernment of inflation dynamics. The use of quarterly average alsoallows the BoT and the public to detect fasterwhether inflation will fall outside the target range compared with annual or longer-period averages. Furthermore, it is consistent with inflation forecast from the BoT's macroeconomic model that the Monetary Policy Committee(MPC) employ in making monetary policy decision, which is available in quarterly frequency.
TheMPC thus considered the 0-3.5 percent target range for quarterly-average core inflation to be appropriate for the Thai economy.The target band width waswide enough to provide flexibility for monetary policy to help cushion economic growth from any temporary shocks. The range target alsominimized the need for the MPC to adjust monetary policy stance frequently to movements of inflation, thereby reducing interest rate volatility, which in turn enables smooth economic and financial activities.
Inflation target in 2009
The Bank of Thailand Act (No.4) B.E. 2551, explicitly specify procedures for reviewing monetary policy target in Section 28/8:
"By December of each year, the Monetary Policy Board, with a corporative agreement with the Minister of Finance, shall determine targets of monetary policy for the following year which shall be regarded as the guideline for the State and the BOT in implementing any measures to maintain the price stability. The Minister shall propose the agreed targets of monetary policy to the Cabinet for approving. Upon the approval, it shall be published in the Government Gazette."
Accordingly, the MPC and the Minister of Finance have carefully considered an appropriate inflation target for 2009, taking into account various important issues, and mutually agreed to propose a new inflation target for 2009 for which the MPC would
(1) Retain the use of quarterly average inflation target for the continuity of policy implementation.
(2) Narrow the target range from 0-3.5 percent to 0.5-3.0 percent. The lower bound of the target range was adjusted upwards by 0.5 percentage points in order to reduce the probability of deflation, while the upper bound was lowered by the same amount to signal unchanged monetary policy stance. The Cabinet approved the above target range on September 1, 2009.
Inflation target from 2010 to 2014
The MPC and the Minister of Finance have agreed to maintain the inflation target at 0.5-3.0 percent in each year. This target range was considered appropriate in supporting stable and sustainable economic growth going forward for the following reasons:
(1) Low and stable inflation would enable the economy to grow on a sustainable path in the long run.
(2) The target range of 0.5-3.0 percent was in line with prevailed inflation rate of Thailand's trading partners and competitors, which would help maintain the country's export price competitiveness.
(3) The low inflation target would help build up confidence of consumers and businesses in making consumption and investment plans.
Inflation target in 2015
The MPC and the Minister of Finance have agreed to propose a new monetary policy target for 2015. The new target was set for the annual average of headline inflation at 2.5 percent with a tolerance band of
± 1.5 percent. This replaced the core inflation target which had been adopted since the introduction of the inflation targeting framework. The rationales and details of such changes were as follows:
(1) The rationales for adopting headline inflation as the policy target
Despite the success of the inflation targeting framework with core inflation as a policy target in achieving price stability, some deficiencies with respect to the use of core inflation may reduce its effectiveness going forward. Compared to core inflation, headline inflation was better in reflecting changes in the cost of living since it captured changes in prices of all goods and services in the consumption basket, including raw food and energy prices which account for 27 percent of the basket. Therefore, headline inflation was more in tune with the public's understanding of what constitute the cost of living, and was used as a reference for consumption and saving decisions by households and for investment and price setting decisions by businesses. In addition, in recent years, core inflation has somewhat lost its ability to track overall inflationary pressure as it has diverged from headline inflation for much longer time period, compared to the past. This was likely because changes in raw food and energy prices hada larger influence on inflation dynamics.
Therefore, adopting headline inflation as a policy target wouldfacilitate the central bank's communication with the public regarding monetary policy decisions and also strengthen monetary policy effectiveness in anchoring long-term inflation expectations. Lastly, every country that adopted the inflation targeting framework currently used headline inflation as a policy target.
(2) The appropriateness of setting the point target for headline inflation at 2.5 percent onan annual average basis with a tolerance band of± 1.5 percent
Switching from the range to point target gave a clearer signal to the public regarding the commitment of monetary policy towards maintaining price stability, which should help strengthen its effectiveness in anchoring the public's long-term inflation expectations. Nevertheless, the tolerance band was needed to provide some flexibility for monetary policy to accommodate temporary fluctuations in raw food and energy prices. Such flexibility was crucial in supporting the economy to grow at its full potentialalongside the mandate to preserve price and financial stability. The band width at 1.5 percent was considered to be appropriate in accommodating volatilities of raw food and energy prices to some extent.
(3) The switch from a quarterly average to an annual average was intended to reflect the forward-looking nature of monetary policy, which would help improve monetary policy flexibility, and to be in line with revisions of monetary policy target which had to be done cooperatively by the MPC and the Finance Minister on an annual basis.
Inflation target in 2016 and as the medium-term target
The MPC and the Minister of Finance have agreed to propose the annual average of headline inflation at 2.5 ± 1.5 percentto be the monetary policy target for 2016 and the medium-term target. This target was considered appropriate due to the following reasons:
1) It was consistent with economic fundamentals. The mid-point of the target at 2.5 percent was in line with long-term inflation outlook, which were conducive to supporting the economy to expand at its full potential.
2) Itwas close to inflation targets of developing countries that adopted an inflation targeting framework, which would help maintain the country's price competitiveness.
3) It has so far well-anchored the public's inflation expectations, reflectedby long-term inflation expectations that remained close to the mid-point of the target.
The purpose of additionally setting the medium-term target was to comply with time lags the effects of monetary policy were fully transmitted to the economy and inflation. Moreover, it allowedhouseholds and businesses to plan their consumption and investment efficiently.
The medium-term inflation target and the target in 2017-2018
The MPC and the Minister of Finance have agreed to maintain the annual average of headline inflation at 2.5 ± 1.5 percent as the medium-term target and the target for 2017 and 2018. The target at this levelwas considered conducive to supporting the economy to expand at its full potential.Also, it has so far well-anchored the public's inflation expectations, reflected by long-term inflation expectations that remained close to the mid-point of the target. Moreover, it helpedpreserve the country's price competitiveness. The tolerance band of ± 1.5 percent was also considered appropriate and sufficient to accommodate volatilities that may cause future inflation to deviate from the mid-point of the target in the short run. Nevertheless, changes in the global and Thai economic structuremay affect inflation dynamics and outlook going forward. Therefore, the MPC would monitor and study thosestructural developments in order to ensure that the setting of monetary policy target and monetary policy implementation in the futurewereappropriate and were conducive toachieving the targets for price, economic growth and financial stability in an effective manner.
In the case that headline inflation breaches the announced target
A mutual agreement between the MPC and the Minister of Finance states that
"In the case that headline inflation breaches the inflation target specified at 2.5 percent with a tolerance band ± 1.5 percent, the MPC shall explain reasons why inflation has deviated from the target, policy actions that the MPC will take to deal with it, as well as the period the MPC expects inflation to return to the target. The MPC are also required to report the progress of their policy actions to the Minister of Finance in a timely manner."