Inflation dynamics and its implications for monetary policy

Since May 2000, the Bank of Thailand adopted inflation targeting as its monetary framework, making price stability the overriding policy objective. Understanding the inflation transmission mechanism is therefore crucial in policy assessment and decision-making. Of particular concern are the key determinants of inflation in Thailand and their relative importance over time. Given the pervasive influence of the exchange rate in the economy, the paper employs econometric models to measure the pass-through of exchange rate movements to domestic prices. In doing so, it evaluates whether the degree of pass-through varies across sectors. Reasons that explain the weak exchange rate pass-through include: 1) changes in firms’ pricing strategy, 2) lower inflation expectations, 3) shifts in housing market structure, and 4) prevalence of administered price measures. The low pass-through has provided more room for manoeuvre in monetary policy. As the pass-through depends on not only the share of import content but also the exchange rate volatility, large fluctuations in the exchange rate can still pose a threat to the inflation target.