Specifically, it reminds us how powerful the expectations channel of monetary policy transmission can be. It is therefore of utmost importance that central banks properly manage expectations so as to maximize monetary policy effectiveness and maintain policy credibility. This draws me to the focus of my talk this evening: the limits of monetary policy, namely, what monetary policy can and cannot do. Given unprecedented economic headwinds of various sources, monetary policy around the world has been under immense demand. But these expectations, if unrealistic and not met, could damage central bank credibility, and end up diminishing central banks’ influence, with unnecessary costs to the economy. Thus, it is important that central banks establish realistic public expectations on their policy. But before I turn to that topic, let me first review current economic conditions, the outlook for the Thai economy, and recent monetary policy response. Recent economic developments and monetary policy response Despite robust economic growth of last year, the Thai economy started out this year with moderation. Growth in the first quarter at 5.3 percent compared to the same period last year was lower than what we had expected. Part of this slowdown may have been a natural reversion to a more normal pace of growth after a strong post-flood acceleration. But that alone may not explain the whole story. Evidently, the recent slowdown in private consumption also owed in part to lower farm income and higher household debts which may have held back consumers’ willingness to spend.

Impact on the supply of credit and capital allocation How do covered bonds impact the supply of credit and capital allocation? Capital requirements under Basel II and III incentivise banks to supply residential mortgage lending. The introduction of IRB models for calculation of capital requirements have resulted in low risk weights for residential mortgages. This may encourage leveraging. Some countries where large shares of covered bonds are backed by residential mortgages, have experienced relatively strong growth in residential mortgage lending and brisk house price growth. The availability of a large and liquid covered bond market may have facilitated this development. One would expect that the emergence of a vibrant residential covered bond market would generally deepen fixed income markets through larger volumes and better liquidity. The cheaper financing of residential mortgages through covered bonds has been reflected in household lending rates. In combination with very low risk weights and corresponding low capital requirements on residential mortgages, banks may have favoured such lending. As a result, corporations seeking financing may be pushed into bond markets through a crowding out effect. In addition, a vibrant market could make bond financing more attractive and pull corporate borrowers to the market. Higher interest rates on banks’ corporate loans may contribute to this effect. In some of the markets in Europe that have seen substantial deleveraging, loans to SMEs have been provided at steep interest rates. However, the economic situation and investment demand in general are probably much more important in determining overall growth in investment financing by banks.