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The effect of trade openness and exchange rate on inflation targeting in Thailand

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  • Luangaram, Pongsak
  • Wongpunya, Nipit

Abstract

Over the past decade, many developing nations have adopted inflation targeting within their monetary policy strategy, with varied approaches to exchange rate flexibility. This paper investigates if monetary policies in economies with high trade openness should integrate exchange rate movements in setting interest rates. Conventional micro-founded models suggest limited benefits from including exchange rates in policy rules. However, using a dynamic stochastic general equilibrium framework focused on Thailand, a small open economy with high trade openness, we find that responding to exchange rate changes with policy rates enhances welfare, more so than disregarding these fluctuations. Additionally, we observe that increased trade openness leads to a flattening of the Phillips curve and hence requires a stronger policy response to deviations from the inflation target. Our findings highlight the critical role of considering exchange rate movements and the degree of trade openness in formulating monetary policies.

Suggested Citation

  • Luangaram, Pongsak & Wongpunya, Nipit, 2024. "The effect of trade openness and exchange rate on inflation targeting in Thailand," Journal of Asian Economics, Elsevier, vol. 92(C).
    • Handle: RePEc:eee:asieco:v:92:y:2024:i:c:s1049007824000289
    DOI: 10.1016/j.asieco.2024.101733
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    More about this item

    Keywords

    Small open economy model; Monetary policy rule; Exchange rate; Inflation targeting; Trade openness; Thailand economy;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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