Understanding monetary policy in Malaysia and Thailand: objectives, instruments and independence

December 2006

Abstract

This paper sets out to update the author's overview of monetary policy in East Asia, presented at the Reserve Bank of Australia in 2001 and subsequently issued as a SEACEN Centre Occasional Paper. At the request of the Hong Kong Institute of Monetary Research, however, this paper focuses more narrowly on monetary policy in Malaysia and Thailand.

This tale of two policies features a broadly similar pursuit of price stability, in one case outside of, and in the other case within, an explicit inflation targeting framework. It features orientations to exchange rate stability: one until July 2005 explicitly bilateral and since evidently so; and the other looser and evidently effective. It features similar but not identical assignments of instruments to the achievement of these objectives. And both central banks set policy enjoying considerable behavioural independence, which might be usefully strengthened by greater legal independence.

This paper's survey of more recent events and its narrower focus allow an examination of how the two central banks have responded to the challenge of higher energy prices in 2004- 05. We find that the fiscalisation of energy costs has reduced the challenge in Malaysia, while mostly just delaying it in Thailand. Given the need in an inflation targeting framework to specify the operating definition of inflation, there was a risk in Thailand of an inappropriate response to energy prices that not only showed great volatility but also a significant trend. In the event, the inflation targeting framework in general, and its focus on a core measure of inflation in particular, have not gotten in the way of an appropriate response to this upward trend in energy prices.