Prasarn Trairatvorakul: Monetary policy in an interconnected global
economy
Opening remarks by Dr Prasarn Trairatvorakul, Governor of the Bank of Thailand, at a
conference co-hosted by the Bank of Thailand and the International Monetary Fund,
Bangkok, 1 November 2013.
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Distinguished Participants, Ladies and Gentlemen,
I am delighted to welcome you to this conference on "Monetary Policy in an Interconnected
Global Economy," co-hosted by the Bank of Thailand and the International Monetary Fund. I
would like to especially thank our international guests who have travelled a long way to be
with us today. This conference will focus on several issues pertaining to cross-country
linkages, international shock transmission, and how monetary policy should be conducted in
response to global spillovers.
One of the most important trends over the past decades is the rapid integration of
international trade and finance. Trade in goods and services, as a share of world GDP,
increased from around 15 percent in the early 1980s to around 25 percent before the start of
the crisis in 2007. These developments reflect, in part, the increasing internationalization of
production through vertical trade linkages. We have also seen a significant increase in
financial integration. While the annual growth in world trade over the past 40 years has
exceeded the growth in world GDP by around 2.6 percent on average, growth in international
external positions outpaced growth in world GDP by almost double that - around 4.8 percent.
What are the implications of these tighter trade and financial linkages? Most
prominently, global interconnectedness implies large and swift transmission of shocks across
countries. A seemingly localized supply shock, such as the tsunami in Japan or the floods
in Thailand two years ago, created ripple effects in various parts of the world by disrupting
the global supply chain of production. From the perspective of most Asian economies, the
abrupt economic contraction in the US and the euro area during the financial crisis were
examples of external
demand shocks.
While such "real spillovers" generated by supply or demand shocks can be quite
damaging, the avenues for dealing with them are apparent and relatively
uncontroversial. Fiscal automatic stabilizers should be allowed to work fully and monetary
policy could be eased to cushion the impact so long as medium-term inflation expectations
are contained. Calibrating the policy response to these shocks may not be straightforward,
but they do not, in of themselves, pose challenges to the underlying framework of policy.
On
the contrary, "financial spillovers" associated with extraordinary monetary policy
easing in advanced economies have prompted many central banks and academics to
do some soul searching about the appropriate framework, not just for monetary
policy, but also for regulatory and capital account policies that can best deal with
these shocks.
It has been around five years that the US federal funds rate has been kept at the zero lower
bound, and this has been supplemented with multiple rounds of large-scale asset purchases.
The federal funds rate would likely remain unchanged for another year or two, based on the
information available today, and the winding down of the bond-buying program will come
eventually. Monetary authorities in other advanced economies have also employed policy
tools with similar features albeit with some variations in the timing, scope, and size.
This configuration of monetary policies in major countries has created a challenging
environment for small open economies to conduct policy. In the post-crisis period, the
relative fundamental strength of emerging market economies was already drawing in
substantial capital inflows. The additional push from this extraordinary stimulus, and the
reach-for-yield behavior associated with it, has compounded the pressure. Many emerging
market central banks have found themselves at critical junctures where broad reappraisals of
their monetary and capital account policy frameworks were necessary.
Take Thailand as an example. Since the beginning of the episode, we have adopted a
multi-dimensional response to the spillovers. Currency appreciation was the main
cushion against rising inflows. At times when exchange rate volatility became excessive in
our view, we undertook some foreign exchange intervention. But we were mindful of
intervention costs and its limited effectiveness. We also further deregulated controls on
outflows. This was part and parcel of our longer-term plan to encourage outward investment
by Thais. At the same time, we raised the policy interest rate in response to expanding
domestic demand, rising price pressures, and strong credit growth. There was a spirited
public debate whether such rate increases would invite more capital inflows. But we viewed
that other factors, such as the strength of the domestic economy and high risk appetite of
international investors, played a larger role in inducing capital inflows than a gradual increase
in the policy rate. Our concern for medium-term financial stability was also a key element of
policy deliberations at the time.
Subsequently, things became more challenging as the Thai economy suffered
As the boost from the government's temporary stimulus measures
domestic setbacks.
dissipated at the start of this year, domestic demand slowed down markedly. At the same
time, domestic credit growth was still quite high, stock prices continued to advance, and
activity in the housing market remained brisk. Moreover, portfolio capital inflows continued
and the baht was appreciating. This presented a dilemma and was an example of the
difficulties posed by policy spillovers. Against the backdrop of weak global demand, we
cut the policy interest rate. We contemplated the use of certain prudential measures,
including those on capital flows, in order to complement domestic monetary policy as well as
offset some of the impact of capital inflows on domestic financial conditions. But since the
QE tapering talk began in earnest in May, the global financial environment changed
dramatically, and with it the nature of the policy trade-offs.
The communication by the Federal Reserve about possible tapering of its bond
purchases was a key turning point for global financial markets. Financial conditions
suddenly tightened in response. Long-term interest rates rose in the US and emerging
market yields increased even more, reflecting a reversal in risk appetite. The prospect of Fed
tapering became a key consideration for monetary policy in emerging market countries. In
most countries monetary policy remained tight in order to lean against excessive currency
depreciation; a few countries raised their policy rates in an attempt to stem capital outflows.
For some countries, as economic activity softened and inflation fell, monetary policy may
have ended up being tighter than intended as a result of tensions caused by policy spillovers.
At this juncture, the key question is how to design or adjust policy frameworks to
cope better with global interconnectedness while preserving monetary policy
independence. I hope the conference will help shed further light on this.
In doing so, we have to be mindful that global liquidity conditions will continue to
largely depend on the macroeconomic conditions of the reserve-issuing countries.
Currently the US dollar dominates the international reserve system as a safe asset. The
continuation of this role rests on some basic requirements. A reserve-issuing country has to
illustrate a good track record of prudent macroeconomic policy. And as recent events have
reminded us, there is a large fiscal element to this.
One cannot separate the status of a
reserve currency from the solvency of the sovereign. The use of the US dollar as an
international store of value and medium of exchange very much depends on the continued
credibility of the US Treasury in honoring its debt obligations.
In terms of monetary policy, it is understandable and will continue to be the case that
the Federal Reserve will focus on its own mandate in setting policy. But as the US
dollar is used heavily abroad, the effective US dollar currency area extends well beyond US
borders. The Federal Reserve sets policy for this wider currency area, not just the 50 US
states. There have been a lot of discussions about how policy cooperation and coordination
may offer scope for improvement. But a practical solution still seems elusive.
Ladies and Gentlemen,
In closing, let me offer my special thanks to the distinguished speakers for taking part in this
important endeavor and for sharing with us your expertise. All of us here very much look
forward to your contributions throughout today and tomorrow. I would also like to thank the
IMF - in particular, the Regional Office for Asia and the Pacific - for kindly co-hosting this
event. To all conference participants, I welcome your spirited discussions as I have already
noticed there are many experts present among us. Thank you for being here. I wish you a
fruitful conference and a pleasant stay in Thailand.