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  BIS central bankers’ speeches  1  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 domestic setbacks. As the boost from the government’s temporary stimulus measures 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.