V. Monetary Policy
- Erik Offerdal, Kalpana Kochhar, Louis Dicks-Mireaux, Jianping Zhou, Mauro Mecagni, and Balázs Horváth
- Published Date:
- December 1996
What role did monetary policy play in the adjustment process in Thailand, and what were the consequences for investment and output? In view of the fixed exchange rate and the relatively open capital account, one must first examine the scope for discretionary monetary policy. Empirical evidence suggests that there was some scope for independent monetary actions, especially in the short run, although the financial sector reforms that were implemented in the early 1990s have narrowed that ability.19
How tight were monetary conditions during the adjustment period of the early 1980s? Relevant indicators include the level of real interest rates, movements in the differential vis-à-vis foreign interest rates, changes in the real rate of growth of private sector credit, and changes in the growth of reserve money. Most of the adjustment period witnessed historically high real interest rates, which peaked in 1984–85 (Figure 9). Real interest rates were consistently higher than growth rates of actual and potential real GDP—the latter is relevant because, over the long run, it should be related to the rate of return on investment. Real interest rates that are significantly and consistently above the long-run growth rate can be seen as indicative of, among other things, excessively tight monetary conditions. Moreover, Figure 9 shows that the gap between domestic and foreign real interest rates widened during this period.
Figure 9.Interest Rates and Growth Rates
Sources: International Monetary Fund, International Financial Statistics (various issues); and IMF staff estimates.
1Calculated using the Hodrick-Prescott filter procedure.
2Ex post real interest rates, adjusted for consumer price inflation.
3Defiated by the consumer price index.
4Differential between Thai lending rates and the U.S. prime lending rate.
As regards the growth rates of credit variables, private sector credit growth in real terms declined sharply during the adjustment period. Likewise, the growth rate of reserve money fell from an annual average of 16 percent in 1978–80 to below 9 percent in 1981–86 before increasing sharply to an average of over 17 percent in the 1987–93 period. Thus, all indicators suggest that monetary conditions were tight, especially in the later years of the adjustment period. Indeed, since fiscal policy was not contractionary for most of this period, tight monetary conditions appear to have been an important policy factor accounting for the slowdown in aggregate demand and the emergence of an output “gap” in this period (see Figure 4). However, it is difficult to disentangle the effect of tight credit conditions from the impact on output growth of the slump in commodity prices and the global recession, which depressed export receipts, business sentiments, and domestic demand.
Figure 10 plots programmed and actual growth rates of total domestic credit and private sector credit during the adjustment period. For total credit growth, actual credit growth slightly exceeded programmed credit growth during the early years of adjustment. The 1985/86 adjustment program called for continued tight credit conditions to contain the inflationary impact of the devaluation. In real terms, credit was to grow by less than 10 percent. In the event, actual credit growth turned out to be considerably slower than programmed, largely as a consequence of the stagnation in private domestic demand.
Figure 10.Actual Versus Programmed Growth in Credit
Sources: Thai authorities; International Monetary Fund, International Financial Statistics (various issues); and IMF staff estimates.
1“Program” refers to programmed credit growth under the first program of each of the three IMF stand-by arrangements with Thailand during this period.
2Includes nonfinancial public enterprises.
On the basis of empirical estimates of the determinants of private investment (see the appendix), the high real lending interest rates during this period did restrain investment growth. At the same time, however, the conservative stance of monetary policy helped to translate the nominal devaluation of 1984 into a sustained real depreciation, thereby laying the foundation for the marked success of expenditure-switching policies that was crucial to Thailand’s rapid recovery after stabilization.
More fundamentally, an important lesson from the conduct of monetary policy in Thailand concerns the benefits that accrue from long-run monetary discipline and the high degree of policy credibility associated with it. These attributes allowed a quick reversal of inflation and the rapid shift in resources toward the traded-goods sector in the mid- to late 1980s to be achieved without a recession.