Central banks’ balancing act

Central banks’ balancing act

In the seven decades since it was founded, the Bank of Thailand has contributed substantially to development efforts and played a crucial role in maintaining the country’s economic stability, modernising the Thai economy and improving people’s standard of living. The Bank restored economic activities, tamed inflation and re-established international partnerships during the postwar period. It took the lead in developing financial infrastructures, including establishing the first domestic banknote printing facility, introducing modern banking regulations and setting up modern payment systems. It also participated in setting up the Thai capital market and the Securities and Exchange Commission.

The 1997 Asian financial crisis was a turning point for the Bank. This painful experience was marked by the bursting of the real estate bubble, massive corporate foreign debts, depleted international reserves and sharp devaluation of the baht. The fallout was devastating and left millions financially insecure. But the crisis presented opportunities for reform. The Bank of Thailand Act was amended to solidify the central bank’s operational independence and strengthen its governance and accountability. This enabled it to respond effectively to changes, adopt a long-term approach to policies, carry out prudent – yet sometimes not politically popular – actions and build stability. As a result, the Thai economy is resilient to external and internal shocks, such as the 2008 financial crisis and natural disasters.

Independence is one of central banks’ most important attributes, but the way they exercise this has evolved. Central banks must look to the longer term to weather change and ensure autonomy.

International capital markets are increasingly linked, resulting in the spillover of global financial conditions into domestic markets. This compromises central banks’ control of domestic liquidity. As quantitative easing winds down in advanced economies and unforeseen events shake international politics, capital flows are becoming increasingly volatile. The normalisation of monetary policy is just beginning, and the process will be littered with challenges. Under these conditions, economies’ buffers will be weaker.

The effectiveness and limits of existing policy instruments will be tested. Free floating exchange rates may stabilise or amplify the repercussions of capital flow volatility. To navigate the impact of globalised financial conditions, central banks will need to revisit their policy frameworks and tools.

Business models, consumer demand and production processes must contend with powerful secular forces. These include changing demographics, globalisation, populism and widening inequality gaps. They impact monetary policy transmission mechanisms and complicate central banks’ jobs. They also raise the question of the role of central banks in fostering structural changes. It is possible addressing these points goes beyond the scope of central banks’ mandates. However, in many countries, it could be crucial for ensuring long-term stability. The extent to which central banks can be involved in broader economic issues and reform policies is unclear. They should partner with different agencies, but navigating political economy may be just as important. With the need to address structural transformation, central banks’ limited role and narrow mandates could be under pressure, especially in emerging countries.

Rapid changes in technology have reshaped how consumers and businesses interact. In the financial sector, the rise of financial technology and cross-border payment technologies has introduced new players  outside central banks’ regulatory umbrella. These can disrupt the financial landscape and erase national borders. This has implications for central banks, considering that much of their work – monetary policy, banking supervision, and payment and settlement systems – is based on a world with national borders. Nevertheless, central banks can benefit from leveraging new technologies such as big data analytics, machine learning and distributed ledger technology. Central banks must find the balance between allowing innovation to prosper and managing the key risks. Financial, structural and technological change could challenge central banks’ independence.

Veerathai Santiprabhob is Governor of the Bank of Thailand.

This article is based on a speech given by the governor on 9 October in Bangkok at a high-level seminar organised by OMFIF in association with the Bank of Thailand on shaping the future of central banks.

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