traditional monetary policy which focuses on domestic dynamics of inflation needs to be reconsidered. as a result of globalization, the prices of important commodities and goods tend to move together, making external price shocks a more and more important determinant of domestic inflation. fluctuations in oil prices and other commodity prices, or even a sustained period of cheaper or dearer exports, can change global inflation dynamics. the spike in oil and commodity prices last year, which initially appeared as a supply shock at the individual country level, in fact represented economic overheating at the global scale, and domestic monetary policy tightening may not have been the most effective way to deal with this situation in the global context. in addition, at the present juncture, the unprecedented and contagious slowdown in each country ’ s economies as a result of global linkages means that monetary policy now needs to respond to the monetary policy stance in other countries. this has added an extra international dimension to policy making, in addition to previous considerations such as the impact via capital flows and trading partners ’ economies. 4. testing the limits of monetary policy under globalization but what exactly are these changes that globalization has brought about to traditional monetary policy? and in particular, how have these changes affected central banks? the first aspect has been the challenge to the basis of our traditional monetary policy decision - making process. traditional conduct of monetary policy would rely on the accuracy of our forecasts of the economy, of inflation dynamics, and of our understanding of how the economy works. with globalization, making accurate economic forecasts become more difficult. the recent economic cycle has demonstrated that shocks to the economy and the price level have been both rapid and frequent. this is most clearly demonstrated by the volatility in inflation in the past year. in the case of thailand, headline inflation peaked at 9. 2 % in july last year, but has fallen dramatically to - 0. 4 % in january. while it is natural for forecasts to be revised in light of new developments and information, a concern arises that globalization is likely to have changed the various relationships in the economy. this is particularly timely now, when fear and uncertainty takes over rational behaviour. and if our models are still based on assumptions which have not incorporated these changing relationships, then we are likely to make systematic errors in our forecasts. as a result of this volatility in inflation and the marked slowdown in global output, many central banks have had to reverse their tightening cycles – originally conducted to tackle

warm and not too cold, and stable disequilibrium. this is an episode in our history where variability of growth in real output has declined along with the variability in inflation. along the way, imbalances in the global economy began to build up. the imbalances manifested themselves in huge trade surpluses and an accumulation of foreign exchange reserves in the countries which relied on export - oriented growth – including those in the asian region. they were reflected in the dollar revenue which was subsequently reinvested in us financial markets – which in turn helped to finance the us saving deficit, permitting these imbalances to remain uncorrected for a prolonged period of time. and as a result, asset price bubbles were also allowed to persist for a prolonged period as well. all was well as long as everyone continued to grow. however, as emerging markets opened up, global demand, and particularly demand from growing economies like china and india, drove up the prices of oil and other global commodities. many economists began to predict a structural shift in global demand and changing dynamics of global inflation which would effect domestic prices and make inflation higher and more persistent. 3. coping with the global financial crisis at the same time, problems were brewing on the financial side in the advanced economies. i will not lay out the causes of the financial crisis here, as that has been discussed widely elsewhere. in a nutshell, the slowdown in the us housing market, coupled with a mix of troubled banking practices, regulatory blind spots, and absolute faith in the market mechanism, among other things, led to a financial crisis in advanced economies. but the important point here is that financial innovations, coupled with technological advances in communications, helped to link financial markets across the globe. this globalization of financial services allowed the collapse of major financial centers to spread to the rest of the globe so efficiently. in fact, these very financial instruments which had been earlier used to diversify risks turned out to be the very means for spreading contagion. the spread of the impact of the financial crisis onto the global real economy through the trade channel changed the world ’ s economic outlook rapidly and dramatically. this had a drastic impact on the inflation outlook, and the threat of inflation has rapidly shifted to one of possible deflation. at the same time, central banks are running out of traditional monetary policy ammunition to fight the slowdown in growth and potential deflation – namely cutting interest rates. given the increasing influence of external factors on global inflation dynamics,