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Roles of Exchange Rate in Monetary Policy under Inflation Targeting: A Case Study for Thailand

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  • Chayawadee Chai-anant

    (Bank of Thailand)

  • Runchana Pongsaparn

    (Bank of Thailand)

  • Kessarin Tansuwanarat

    (Bank of Thailand)

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    Abstract

    This paper addresses the roles of exchange rate in monetary policy under inflation targeting (IT) regime, with a particular focus on Thailand. The analysis will examine the role of exchange rate as a channel of monetary policy transmission mechanism, its role as a shock absorber and the plausibility of an additional role in mitigating inflationary pressure. To investigate these issues, the paper primarily employs a Small Structural Model to capture the relationship between the exchange rate and other macroeconomic variables, in conjunction with other statistical and econometric techniques. The analytical results indicate that, besides its conventional roles under IT, the exchange rate could take on an additional role in alleviating inflationary pressure only under specific circumstances. The finding suggests that the impact of exchange rate management in bringing down inflation is rapid and short-lived, while the impact on output is smaller but more long-lasting than the use of interest rate policy. Thus, the use of exchange rate in curbing inflation is only appropriate in the case of temporary inflation shock. It is, however, subject to limitations. The effectiveness of exchange rate management via foreign exchange intervention, i.e. the degree of controllability, is an important concern. Moreover, prolonged intervention can also distort resource allocation and delay structural adjustments of the real economy.

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    Bibliographic Info

    Paper provided by Economic Research Department, Bank of Thailand in its series Working Papers with number 2008-03.

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    Length: 60 pages
    Date of creation: Mar 2008
    Date of revision:
    Handle: RePEc:bth:wpaper:2008-03

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