MONETARY AND FISCAL POLICIES ON INFLATION: EVIDENCE FROM PRECRISIS AND POST-CRISIS PERIODS IN THAILAND

The purpose of this study is to examine the long-run relationship monetary and fiscal policy on inflation in Thailand by employing an Autoregressive Distributed Lag (ARDL). This study uses quarterly data from 1980: Q1 to 2017:Q1 and divides the sample data into pre-crisis period (1980Q1-1997Q3) and post crisis period (1997Q4-2017Q1). The results revealed that the longrun relationship between government spending and inflation was positive. The results implied that government spending was one of the important components when determining the inflation. However, interest rate was positive in pre-crisis and negative in post-crisis. The results indicated that monetary policy is more effective on inflation in the post-crisis period. Both precrisis and post-crisis period show that fiscal policy is more effective in influencing the inflation in Thailand. These results suggest that inflation in Thailand inflation is highly sensitive to the change in monetary and fiscal policies, especially as it emerges from a financial crisis. Keyword: Monetary policy, Fiscal policy, ARDL. JEL Classification: E52, E62 1.INTRODUCTION The main objective of the monetary policy is to maintain price stability. Thus, the determinant of the inflation is an important issue and it draws a lot of interest of both policymakers and monetary authorities. Monetarist’s claimed that inflation is always a monetary phenomenon, thus, the government spending will not affect the price. However, according to the fiscal theory of price level, fiscal policy is important. It is often argued that inflation is cause by the monetization of budget deficits especially in developing countries (Tekin-Koru and Özmen, 2003). Thus, fiscal policy could be one of the sources of the inflation. There is no clear answer that whether monetary or fiscal policy has significant impact on inflation. Further, the effectiveness of monetary and fiscal policy on inflation is likely to be affected by external events such as the 1997 Asian Financial Crisis. This is because shocks from such events may have depressing effects on the entire economy including the price level. However, there is less studies focus on Asian countries such as Thailand. The inflation in Thailand has remained remarkably low and stable after 1980s. As shown in Figure 1, there has been a marked decline in the inflation during the crisis period. Thus, this paper aims to International Journal of Business Management and Economic Review Vol. 2, No. 04; 2019 ISSN: 2581-4664 http://ijbmer.org/ Page 127 answering the following three questions: (1) Does monetary policy affect the inflation? (2) Does fiscal policy affect the inflation? And (3) Does crisis change the effectiveness of monetary or fiscal policy on inflation? Figure 1 Thailand’s Consumer Price Index (2010=100), 1980-2018 The purpose of this paper is twofold. Firstly, to examine the long-run relationship among inflation, interest rate and government spending in Thailand and secondly, to examining the impact of monetary and fiscal policy on inflation preand post-crisis. The rest of the paper is organized into five sections. Section 2 reviews the literature, Section 3 describes the methodology and model specification. Section 4 discusses the data and empirical results. Section 5 concludes. 2. EMPIRICAL EVIDENCE ON THE RELATIONSHIP BETWEEN THE MONETARY POLICY, FISCAL POLICY AND INFLATION Fiscal policy has been proven to have a positive impact on inflation in a number of studies, such as the case of Greece (Shabbir, Ahmed & Ali, 1994) and developing countries (Darrat, 2000; Narayan & Narayan, 2006; Habibullah, Cheah & Baharom, 2011; Jalil, Tariq & Bibi, 2014). In contrast, Karras (1994) found that a fiscal deficit has no inflationary impact. This discovery was consistent with Cottarelli, Griffiths and Moghadam (1998) who focused on industrial and transition economies. Meanwhile, Fischer, Sahay and Végh (2002) and Lin and Chu (2013) revealed that a fiscal deficit was only effective during periods of high inflation, this was supported by Catao and Terrones (2005) who studied high-inflation or developing countries. Some studies have highlighted the importance of monetary policy on the price level. Research carried out by Cioran (2014), Yunana, Michael and Akpan (2015) and Adedamola (2015) found a negative effect of the interest rate on inflation. A common price puzzle was found in empirical studies. This price puzzle refers to a positive interest rate shock leading to an initial increase in the price level, rather than a reduction (Sims, 1992; Christiano, Eichenbaum & Evans, 1994; Balke & Emery, 1994). Furthermore, the research studies by Arin and Jolly (2005) covering Australia and New Zealand and Perera (2016) for Sri Lanka also showed a positive relationship -5 0 5 10 15 20 25 (Annual %) International Journal of Business Management and Economic Review Vol. 2, No. 04; 2019 ISSN: 2581-4664 http://ijbmer.org/ Page 128 between the interest rate and inflation. Several studies have included other variables, such as commodity prices (Hanson, 2004) or the output gap (Bonga-Bonga & Kabundi, 2011) in order to overcome the problem of the price puzzle. However, the price puzzles still remain unsolved. Policy coordination is important in dealing with recessions and financial crises. Freedman et al., (2009) showed that appropriate policy coordination could prevent an economy from experiencing further economic downturns, even during a deep recession and deflation. Besides that, Hutchison, Noy and Wang (2010) concluded that fiscal expansion was more effective than monetary expansion in emerging and developing economies when dealing with financial crises, this result was consistent with that of the study by Fetai (2013). Notwithstanding, the impact of policy coordination on the price level is another concern of researchers. Mahmood and Sial (2011) discovered that fiscal policy was more dominant in affecting prices when compared to monetary policy. Meanwhile, Van (2014) found that both monetary and fiscal policies had no effect on the real GDP, however, monetary policy had a stronger effect on the price level. Tekin-Koru and Özmen (2003) found that monetary growth had a positive impact while budget deficit had a no effect on inflation in the case of Turkish. The findings of Tekin-Koru and Özmen (2003) were similar with Khieu (2014) in Vietnem and Mukhtar and Zakaria (2010) in Pakistan. By investigating the granger causality effects of these two policies on inflation, Lozano-Espitia (2008) discovered that budget deficit granger cause monetary growth and subsequently, monetary growth to cause inflation in Colombia. In all the above mentioned studies, there are lacks empirical work has been carried out in Thailand. Much research has been carried out to analyze the relationship among inflation, monetary and fiscal policies, with mixed results. Most of the studies focus on policy coordination could prevent the economic downturns and deflation, but studies on how effectiveness of monetary and fiscal policy on inflation during financial crises are lack. Further, this study intends to contribute to the literature by examining the impact of monetary and fiscal policy on inflation by compare the effect before and after crisis. Therefore, there is a need to re-estimate the issue.