exchange rate pass through inflation in thailand

Introduction Inflation in Thailand from 2000 to 2010 Literature Review and Methodology Research Result Conclusion

Exchange Rate Pass Through Inflation inThailand

Panit Wattanakoon1

1Faculty of EconomicsThammasat University

Setthathat 2011


Outline

1 Introduction

2 Inflation in Thailand from 2000 to 2010

3 Literature Review and Methodology

4 Research Result

5 Conclusion


The Importance of the Study

Exchange rate plays an important role for the Thaieconomy due to high degree of openness

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% millions

Source: NESDB

Import Export GDP Degree of Openness (RHS)



The process that the change in exchange rate contributesto the change in inflation is called passthrough.Complete passthrough happens when the total adjustmentin exchange rate causes the same magnitude of change toconsumer price index.Incomplete passthrough should be observed these days asmany restrictions come out in both exchange rate andproduct market of one economy.Nevertheless, if the exchange rate does not cause anychanges to the inflation, no pass through is for suchcircumstance.



Change in Exchange Rate

Imported price for intermediate inputs

Imported price to consumers

Cost of Production

Price Level in the economy

Price of Factor of Production


Objective and Scobe of the Study

ObjectiveTo describe the behavior of consumer price index andexchange rate in the interested periodTo explain the relationship between inflation and exchangerate after the 1997 crisisTo investigate the degree of exchange rate pass-throughinflation in Thailand

Scobe of the StudyThailand as a case studyAvoid structural change in 1997, start around 2000 to Aug2011


Inflation and Exchange Rate

Consumer Price Index expresses less volatile pattern asthe Bank of Thailand employs inflation targeting policyBank of Thailand also adopted managed-float exchangerate system, trying to smooth out the fluctuation of theexchange rate.

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% yoy

Source: Bank of Thailand and Bureau of Trade and Economic Indices

B/$ CPI


Inflation and Import

Consumer Price Index moves in the same direction as theimport price index

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Source: Bureau of Trade and Economic Indices

Import Price Index Headline CPI


Inflation and Oil Price

Inflation does get affected by Dubai Oil PriceSpeculation since 2007 accelerated oil price as well asinflation in ThailandEconomic slump and less speculative pressuredecelerated the price level in 2009

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Soucre: Bureau of Trade and Economic Indices and Reuters

Dubai Oil Price (% yoy) Annual CPI (%yoy) RHS


Inflation and Economic Growth

Thai economy just came back from its recession in 2000.Inflation was modest around 2 percent for years before itpicked up around 2005 due to the heating-up economy.Global financial crisis drove down both inflation and GDPgrowth in 2009 before rising in 2010 due to the resilienceof Thai economy.

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Source: NESDB and Bureau of Trade and Economic Indices

Annual CPI (%yoy) GDP Growth Rate (%)


Policy Package

Inflation Targeting Monetary PolicyImplemented since May 2000, targeted core CPI: 0.0-3.5percentChange to 0.5-3.0 percent in September, 2009To be approved by the cabinet, new inflation target aims atcurbing headline CPI within the range of 3.0 ± 1.5 sd.

evaluated each year so more flexible to cope withunexpected shockseasier to understand by the public as it directly reflexesstandard of livinguse standard deviation to be in accordance with othercompetitors

Price Subsidy to Energy PriceOnce energy price increases, supported by oil fund

Price Administration from Ministry of CommerceAsk private sector to hold price of certain necessary goodsso that cost of living is not affected


Literature Review

Various studies employed various models to investigate thedegree of pass through in several countries, incompletefound and decreasing in magnitude over the past years,

Dornbusch (1987),Hopper and Mann (1989),Dwyer, Kent and Pease (1993),Campa and Goldberg (2002) ,Wickremasinghe and Silvapulle (2004),Korthonen and Wachtel (2005),Kiptui, Ndolo and Kaminchia (2005),Mishkin (2008),Barhoumi and Jouini (2008).

This paper will use the model applied in Chai-anant, et al(2008)


Methodology

EquationPt = β0 + β1et + β2mpit + β3oilt + β4Pmt

where:

βi = Cointegrating FactorsPt = Consumer Price Indexet = Exchange Rate (B/$)mpit = Manufacturing Production Indexoilt = Index of retail prices of ULG 95 (BKK)Pmt = Import Price Index


Methodology

To find the short run relationship, the Error Correction Model(ECM) will show the behavior of exchange rate how it correctsitself to the long-run equilibrium

ECM

∆Pt = α0 + α1ECMt−1 +∑p

i=1 γ1i∆oilt−i +∑p

i=1 γ2i∆Pmt−i +∑pi=1 γ3i∆mpit−i +

∑pi=1 γ4i∆et−i

where ECM = Pt − β0 + β1et + β2mpit + β3oilt + β4Pmt


Econometric Test

Unit-root test to find whether the data is stationary whichcan be manipulated in the modelCointegration test with Augmented Dickey-Fuller Test, willbe adopted to find whether the interested variables willreach their long-run equilibrium.


Unit Root Test

Unit Root Test at Level

Variable t-statistics 5% critical value ResultCPI 0.24 -2.88 Non StationaryOil -0.40 -2.88 Non Stationary

Import Price 0.57 -2.88 Non StationaryMPI -0.19 -2.88 Non Stationary

Exchange Rate -0.18 -2.88 Non Stationary


Unit Root Test

Unit Root Test at Difference

Variable t-statistics 5% critical value ResultCPI -11.30 -2.88 StationaryOil -8.90 -2.88 Stationary

Import Price -6.68 -2.88 StationaryMPI -6.02 -2.88 Stationary

Exchange Rate -7.77 -2.88 Stationary


Cointegration Test

ResultPt = 2.0962 + 0.0470et + 0.0595oilt + 0.0708mpit + 0.3596Pmt

R2 = 0.9911Adjusted R2 = 0.9909

* all variables are significant at 0.05 level.

Variable t-statistics 5% critical value ResultResidual -3.31 -2.88 Stationary

It shows that the absolute value of ADF statistics is greater thanthat of critical value. Therefore, Consumer Price Index (P), oilprice index (oil), Imported Price in term of dollar (Pm),Manufacturing production index (MPI), and exchange rate (e)have long-run relationship.


Error Correction Model

ECM∆Pt = 0.0010∗ + 0.0160∆et + 0.0027∆mpit + 0.0642∆oil∗t +0.1775∆Pm∗

t − 0.1406ECM∗t−1

R2 = 0.5552Adjusted R2 = 0.5385

* at 0.05 level of significance

Equation above indicates short-run adjustment toward long-runequilibrium with the change in overall system. Coefficient ofadjustment is -0.1406, which means the error correctionprocess will take place from the actual value to the long-runequilibrium by 0.1406 each period.


Policy Implication

The depreciation and appreciation of Thai baht will havecertain impact to inflation in ThailandThis study reveals that there is 4.70 percent ofpassthrough from exchange rate to inflation, and the valuewill be corrected by -14.06 percent in each period

Jitpokkasame (2007) applied quarterly data from 1995 to2005 and found that the degree of passthrough is 18.35percent, and correcting itself by -17.25 percent per quarter.Chai-anant et al. (2008) found that there is 20.6 ofpassthrough for the Thai economy with correction processby -13.0 percent in each month.

This paper can also conclude that overtime, lower degreeof passthrough is identified.


Policy Implication

A decline in degree of passthrough overtimes

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Coefficient of Passthrough

Note: X-axis indicates the range of data used from January 2000 to that point in time. Each point represents the

degree of passthrough from each cointegration equation


Policy Implication

Price level will correct itself with higher magnitude than in thepast to achieve long-run equilibrium as there are morerestrictions toward the adjustment.

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Correction Coefficient

Note: X-axis indicates the range of data used from January 2000 to that point in time. Each point represents the

correction coefficient from each ECM


Policy Implication

With less transmission between exchange rate andinflation, currency flexibility will be realized since thechange in exchange rate will not be passing throughdomestic price level that much. So more rooms are forcentral bank to curb with external balances without hurtingthe price stabilityNevertheless, Bank of Thailand still needs to keep theireyes on both currency and inflation management


Limitation and Future Research

This research can also be extended to investigate in detailon each category of goods and services.Other currencies can be added in the model to find theirimpacts to the price level in one economy.


Conclusion

Baht has been appreciating since 2000.Various factors adversly affect inflation in ThailandInflation targeting monetary policy, price administration andspecial programs from government authorities havealleviated inflationary pressure to the Thai economyThe study finds that there is 4.70 percent of pass throughfrom exchange rate to inflation in the long run.In each month, consumer price index will correct its errorby 14.06 percent and achieve its long-run equilibrium


Conclusion

Thank you for your attention

exchange rate pass through inflation in thailand

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