​Songklod Rastapana

Emerging relatively healthy from the world’s most severe economic crisis in seventy years presents an opportunity for Asia including Thailand to become a new global growth engine. But there is certainly no free lunch. The new global economic and financial landscape is also the one with more volatile capital flows, greater financial interconnectedness (among financial institutions as well as with the real economy), and slower global potential growth.
To successfully navigate this new environment, monetary policy makers, particularly those that have adopted an inflation targeting (IT) framework, will need to find ways to overcome two key challenges. The first is how to deal with financial booms and busts. The second is how to achieve the degree of exchange rate flexibility that would support long-term sustainable growth.

In dealing with financial stability risk, policy makers will need to go beyond the traditional understanding of instability formation and assess the “comprehensiveness” of the current policy toolbox. The urgency of this assessment is heightened as we expect more volatile capital flows and greater financial interconnectedness going forward.

An underappreciated linkage and important cause of financial instability is the interplay between the financial sector and the real economy, the so-called “financial system procyclicality”. Understanding the root causes and mechanism of this phenomenon would shed light on current policy debates and future directions, in particular, the role of monetary policy with respect to financial stability and the appropriate prudential measures to be combined with it.

In addressing the second challenge, policy makers will need to examine the role of the exchange rate in supporting the economy. Despite IT’s increasing popularity over the past decade, there is still no consensus on the appropriate role of the exchange rate under this framework. For example, while emerging economies tend to resist flexibility with their concerns on trade competitiveness and currency speculation, more advanced economies tend to lean toward a free float, arguing for its shock absorber role and its conduciveness to efficiency improvement and financial development.

Ultimately, to what degree of exchange rate flexibility a country should adopt depends on the country’s characteristics. From a long-term growth perspective, greater flexibility is clearly desirable. However, if more flexibility is to be implemented, policy makers must be assured of the capability of the economy to withstand sharper exchange rate movements. Whether the Thai economy now has adequate adjustment capacity to tolerate greater exchange rate flexibility thus warrants serious discussion.

In a research paper I recently wrote with my colleagues, titled “The Future of Monetary Policy: Roles of Financial Stability and Exchange Rate”, an “integrated” policy framework that is both comprehensive and forward looking is recommended. With a more resilient financial system through the use of well-designed prudential measures and a proper role of the exchange rate, the policy rate can then be more focused and work more effectively to meet its mandate of maintaining price stability and promoting long-term sustainable growth.

This paper along with the other four on the future of the Thai economy will be presented at the Bank of Thailand’s upcoming symposium on September 21-22 at the Centara Grand Hotel.

The opinions expressed in this article are the author’s own and do not necessarily reflect the official opinion of the Bank of Thailand.