Estimation and Use of the Potential GDP for Monetary Policy for the SEACEN Countries

The objective of this project is to review methodologies of computing the potential output gaps; to survey of international best practice with respect to the estimation and utilisation of potential output and output gap measures; and to identify weaknesses and strengths of the respective methodology. From the literature review, it is obvious that different approaches and estimation techniques can lead to different estimates as potential GDP is unobservable. It is difficult to know which technique performs better. The unobservable characteristic also implies that it is not possible to know precisely the statistical errors of these estimates. Furthermore three types of errors are possible - statistically uncertainty; inadequacy of the model and errors due to the revision to the real time estimates as a result of new data arrival. Noise introduced into the models as a result of supply shocks would also make the estimation of potential GDP difficult. The objective of this project is to review methodologies of computing the potential output gaps; to survey of international best practice with respect to the estimation and utilisation of potential output and output gap measures; and to identify weaknesses and strengths of the respective methodology. From the literature review, it is obvious that different approaches and estimation techniques can lead to different estimates as potential GDP is unobservable. It is difficult to know which technique performs better. The unobservable characteristic also implies that it is not possible to know precisely the statistical errors of these estimates. Furthermore three types of errors are possible - statistically uncertainty; inadequacy of the model and errors due to the revision to the real time estimates as a result of new data arrival. Noise introduced into the models as a result of supply shocks would also make the estimation of potential GDP difficult.

Price Pressure Measurements for Effective Monetary Policy: Methodology and Issues

Notwithstanding several shortcomings of CPI, in the SEACEN region as in elsewhere, for pragmatic purpose, the CPI despite its many flaws is universally accepted as a policy target for monetary policy. This is justified if we examine the construction of the consumer price index itself. Even though the CPI is a noisy signal of the inflationary pressures and it may not necessarily be a good measure of the cost of livings but based on a list of criteria needed for a suitable and appropriate index, other measures of price indices do not fare as well. An important question to ask regarding the construction of CPI is whether asset and wage inflation should form an integral part of price pressure measurement. The study duly notes that it may be problematic for the authorities to implicitly include asset prices in any kind of monetary rules if such prices are highly volatile. However, bearing in mind that monetary policy action often involves long lags, it needs a forward-looking and pre-emptive dimension. Therefore, central banks need to put in considerable effort in forecasting future economic developments that may include movement of asset prices. The study also notes that the movements of wages and consumer price inflation in selected SEACEN countries show some correlated relationships and this may suggest that policy authorities may want to utilise wage and labor cost variables in forecasting CPI inflation. For effective monetary policy, the study also observes that while the debate on whether to use headline or core inflation has yet to be settled, nevertheless core inflation is a vital mean to be used as an input to policy decisions and it also serves as an important tool for communication strategies with the general public. It is also noted that even though core CPI inflation does not fully reflect price level movements, it makes a good operational inflation target because it is an index, which the monetary authorities can be held accountable. The choice of which index to use depends on what is the current rate of inflation. If inflation rate is already relatively high, it probably does not matter much which index is used to calculate inflation as this is of a secondary concern. However, in a low inflationary environment, as different choice of price measurement can yield difference results, it becomes important to use the appropriate index. Therefore, in order to overcome the limitation of the conventional CPI, superlative indices are highly recommended but as a second best solution, the study strongly suggest customising a family of consumer price indices to ensure different CPIs are aptly used for different purposes.

Dynamics of the Inflation Process in the SEACEN Countries

This in-house research project aims to enhance the understanding of the dynamic process of inflation in the SEACEN countries and to assess the effectiveness of monetary policy in the management of inflation in the individual countries.

Economic Openness and Effectiveness of Countercyclical Macroeconomic Policies in the Context of Global Economic Slowdown: Experiences of the SEACEN Countries

This paper intends to provide some insights into whether counter-cyclical macroeconomic policies, in particular fiscal spending is effective tool to stabilising and stimulating the economy in the context of the open economic structure.

Capital Flows and Implication for Central Bank Policies in The SEACEN Countries

The SEACEN economies have liberalised their external accounts and domestic financial markets. The current account is fully convertible in all the countries in the SEACEN region while the capital account is by and large fully convertible in the majority of these countries. Since early 1990s, net capital flow to the SEACEN countries increased steadily until 1996 due to the massive increase in total capital inflows. However, after the financial crisis of 1997, total capital outflows have outweighed total capital inflows resulting in a negative net capital flow. Both domestic factors such as attractive economic growth, attractive interest rates and large current account deficits and external factors such as low world interest rates are responsible for the increased capital inflows in the region. However, determinants of short-term capital inflows vary from that of the total capital inflows. Notably, short-term capital inflows are found to be inversely associated with domestic economic growth. The effects of push and pull factors on capital flows vary across the countries. Recent experiences of SEACEN countries indicate that the US sub-prime mortgage crisis has led to slower capital inflows in the region while domestic political climate, further liberalisation in overseas investment; and, encouragement to invest abroad have accelerated capital outflows. The SEACEN region has benefited significantly from the increased capital inflows mainly in terms of increased investment, higher economic growth, favourable external accounts and developed financial markets. However, capital flows have also led to challenges for monetary and financial stability. The recent experience of SEACEN countries shows that capital flows can create asset price bubbles and induce sharp increases in bank credit while outflow of capital results in lower equity prices and depreciation of exchange rates. Short-term capital inflows are highly volatile and prone to sudden reversals. After 2003, the share of short-term inflow started to become increasingly dominant in the total inflow in the SEACEN region, resembling the pattern of capital flows before the 1997 crisis. Due to the larger share of highly volatile shortterm foreign capital, SEACEN economies are again, facing the risk of massive capital reversals. In order to prevent a repetition of the same problems in the future, SEACEN countries need to encourage more long-term capital inflows rather than short-term ones. To safeguard the financial system and the economy from speculative attacks, authorities need to implement more prudent regulations and cautiously monitor potential areas of such attacks. In order to maintain a conducive monetary stability environment, central banks need to sterilise inflows with appropriate intervention measures. Freer exchange rates allow for more capital flows in and out of the country. However, in the time of distress, the countries that have a free floating exchange rate regime may suffer from larger capital reversals. Therefore, a managed floating exchange regime may be more advantageous during a crisis. The financial markets and economies of the SEACEN countries are currently affected by the global financial crisis, due mainly to external factors. In order to minimise further negative impacts of the crisis on various sectors of the economy including capital flows, to speed up the recovery process, and also to explore the possibility of inventing new economic drivers within the region, coordinated policy measures need to be implemented at the national as well as regional levels.

Sustainability of External Account Deficits

This paper examines the notion of sustainability of current account deficit using the consumption smoothing approach model. Empirical evidences suggest that the current account deficits in Indonesia, Malaysia and the Philippines can be explained by the model. Results also show that prior to the crisis, there was some degree of over-borrowing but it appears that overall, the current account deficits of these countries were sustainable during 1970-1997. The paper notes that for developing countries, it may be optimal to run current account deficits, provided that it is not excessively large. The current account imbalances should also be dealt with at source - excessive domestic absorption, particularly consumption.

Optimal Policy Mix under Financial Crisis

This paper examines ex-post solutions to the recent financial crisis. It is noted that the standard prescriptions of budgetary cuts, tax increases, currency depreciation and high interest rates were not effective. To avoid future crisis and in the context of an open capital market, the paper proposes a longer-run policy strategy consisting of a three-pronged approach: (i) use open market operations to neutralise the liquidity impact of capital inflows; (ii) strengthen bank asset-liability management and risk-focused supervision to ensure that capital inflows are invested productively and safely in order to meet calls at any time for capital outflows obligations; and (iii) adopt managed exchange rate policy that is supported by a strong foreign reserve position, sound money and sound banking policies, and a strong fiscal position.

Impact of Stock Market on Monetary Policy in The SEACEN Countries

This paper examines the relationship between stock market and monetary policy. It is noted that the empirical results show that the returns of Dow Jones are leading "causing" variable to the domestic stock market. Exchange rate also plays a significant part, implying to a large extent the high degree of market integration.

Determination of Equilibrium Real Exchange Rate in Selected SEACEN Countries

The objectives of this project are: to investigate determinant factors influencing the real exchange rate fluctuations; to measure the real exchange rate deviation from the equilibrium; and to provide some guidance for policymakers in implementing exchange rate policy. For the empirical study, five countries out of the eleven SEACEN countries were picked: Indonesia, Korea, Malaysia, the Philippines and Thailand. These countries experienced the recent Asian financial crisis.

The Role of Central Banks in Sustaining Economic Recovery and in Achieving Financial Stability

Whenever a financial crisis occurs, threatening a possible financial meltdown, central banks have to be at the forefront in combating, neutralizing the crisis and restoring financial stability and economic growth. In this regard, the present sub-prime crisis which originated from the US highlights a few key issues for the SEACEN group of central banks. This paper reviews the policy responses to the crisis which include exit policy strategies from stimulus monetary packages. To strengthen the soundness of the financial system going forward, the paper also highlights counter-cyclical and macro-prudential regulations that central banks need to actively look into.SEACEN, central banks, financial stability, prudential regulation, supervision