However, in the current environment where persistent and rapid increases in food and energy prices have been observed for a considerable period, the prevalence of this view has become questionable – especially in the light of current projections that foresee even higher prices in the near future. As a matter of fact, many countries under inflation targeting regime now project that inflation will converge to the target at end-2009 or in 2010, at the earliest. Going through a long period of high inflation is a serious risk for price stability. First, the general price level may shift upwards at a faster rate, as producers and workers in other sectors ask for higher prices and wages in response to the loss of their real purchasing power. The fall in real interest rates due to deterioration in inflation expectations is another risk, since lower real rates will lead to a faster pace of credit expansion. The common factor of these two risks is that persistent supply shocks may turn into demand shocks after a while. Thus, at some point, central banks have to decide to what extent they can tolerate the rise in inflation. As the famous philosopher Karl Popper put it while defining the demarcation problem, “if we do not demarcate a scientific hypothesis, we will be leaving out one of the key steps in verifying the correctness of that hypothesis”. Any theory should be formulated in a way to allow falsification; the circumstances under which the theory fails should be identified.

To meet these challenges from without, it is critical that the Thai economy build strength from within: by continuously improving the flexibility and efficiency of its firms, the resiliency of its households, and the competitiveness of its business environment. But beyond getting the fundamentals right and strengthening them, the Thai economy needs a strategic policy package that builds a system that allows for constant self-correction – one that also let the economy regain its strength quickly after a severe negative shock. That system should be underpinned by a strong link to the world economy, which will encourage innovation and efficiency. Specifically, I should underscore that this approach requires policy markers to focus on achieving three key objectives, namely managing volatilities especially those emanating from volatile global capital movements; building resiliency in both real and financial sectors; and fostering long-term productivity improvement. Looking ahead, the pressing and practical challenges we face in the near term are three-fold and indeed they are also inter-related. They are “hot money” inflows and large inflows in general, pressure for rapid domestic currency appreciation, and finally, the potential loss of monetary autonomy in the sense of independent interest rate policy. Being part of the fast growing Asia, Thailand and its neighbors have become attractive destinations for international investors – although the more powerful underlying reason may ironically be a medium-term flight from US dollar assets since 2002. With large capital inflow comes pressure for these currencies to appreciate. In this experience, some currencies appreciate faster than others.