MONETARY POLICY AND

CENTRAL BANKING

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CHAPTER 5: PHILIPPINE MONETARY

POLICY Objectives:

∙ To learn about the monetary policy in the

Philippines
∙ To understand how banko sentral ng pilipinas
works.

For more knowledge please follow the link provided;

https://www.youtube.com/watch?v=ZyLuvJMND7c

Monetary policy is the monitoring and control of money supply by a central bank, such as the
Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in the
Philippines. This is used by the government to be able to control inflation, and stabilize currency.
Monetary Policy is considered to be one of the two ways that the government can influence the
economy – the other one being Fiscal Policy (which makes use of government spending, and
taxes).[1] Monetary Policy is generally the process by which the central bank, or government controls
the supply and availability of money, the cost of money, and the rate of interest.

Money Supply Indicator

Money supply indicators are often found to contain necessary information for predicting future
behavior of prices and assessing economic activity. Moreover, these are used by economists to
confirm their expectations and help forecast trends in consumer price inflation. One can predict, to a
certain extent, the government's intentions in regulating the economy and the consequences that
result from it. For example, the government may opt to increase money supply to stimulate the
economy or the government may opt to decrease money supply to control a possible mishap in the
economy.
These indicators tell whether to increase or decrease the supply. Measures that include not only
money but other liquid assets are called money aggregates under the name M1, M2, M3, etc.

M1: Narrow Money

M1 includes currency in circulation. It is the base measurement of the money supply and includes
cash in the hands of the public, both bills and coins, plus peso demand deposits, tourists’ checks
from non-bank issuers, and other checkable deposits.[3] Basically, these are funds readily available
for spending. Adjusted M1 is calculated by summing all the components mentioned above.

M2: Broad Money

This is termed broad money because M2 includes a broader set of financial assets held principally
by households This contains all of M1 plus peso saving deposits (money market deposit
accounts), time deposits and balances in retail money market mutual funds.
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M3: Broad Money Liabilities

Broad Money Liabilities include M2 plus money substitutes such as promissory notes
and commercial papers.

M4: Liquidity Money

These include M3 plus transferable deposits, treasury bills and deposits held in foreign currency
deposits. Almost all short-term, highly liquid assets will be included in this measure.

Implications
If the velocity of M1 and M2 money stock has been low, this indicates that there is a lot of money
in the hands of consumers and money is not changing hands frequently.
Generally we would expect that when money supply indicators are growing faster than interest rates
plus growth rate or inflation, whichever is higher, interest rates should possibly be increased. This
should only generally apply when broad measures of money supply growth are higher than narrow
measures, to rule out some of the measurement error issues that could emerge.

Monetary Policy Instruments

Open Market Operations
Open Market Operations consist of repurchase and reverse repurchase transactions,
outright transactions, and foreign exchange swaps.

∙ Repurchase and Reverse Repurchase

This is carried out through the Repurchase Facility and Reverse Purchase Facility of the
Bangko Sentral ng Pilipinas. In Purchase transactions, the Bangko Sentral buys government
securities with a dedication to sell it back at a specified future date, and at a predetermined
interest rate. The BSP's payment increases reserve balances and expands the monetary
supply in the Philippines. On the other hand, in Reverse Repurchase, the government acts
as the seller, and works to decrease the liquidity of money. These transactions usually have
maturities ranging from overnight to one month.

∙ Outright Transactions
Unlike the repurchase or reverse repurchase, there is no clear intent by the government to
reverse the action of their selling/buying of monetary securities. Thus, this transaction
creates a more permanent effect on our monetary supply. "When the BSP buys securities, it
pays for them by directly crediting its counterparty's Demand Deposit Account with the
BSP."The reverse is done upon the selling of securities.

∙ Foreign Exchange Swaps

This refers to the actual exchange of two currencies at a specific date, at a rate agreed upon
the deal date and the reverse exchange of the currencies at a farther date in the future, also
at an interest rate agreed on deal date.
Acceptance of Fixed-Term Deposits
To expand its liquidity management, the Bangko Sentral introduced this method in 1998.
In the Special Deposits Account, or SDA, consists fixed terms deposits by banks and
institutions affiliated with the BSP.

Standing Facilities
To increase the volume of credit in the financial system, the Bangko Sentral ng Pilipinas
extends loans, discounts, and advances to banking institutions. "Rediscounting is a
standing credit facility provided by the BSP to help banks meet temporary liquidity needs
by refinancing the loans they extend to their clients." There are two types of
rediscounting in the BSP: the peso rediscounting facility and the Exporter's dollar
 and Yen Rediscount Facility.

Reserve Requirements
In banking institutions, there are required amounts that banks cannot lend out to
people. They always need to maintain a certain balance of money, which are called
"reserves". Once these reserve requirements are changed and are varied, changes in
the monetary

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supply will be observed greatl

Two Forms:

1. Regular or Statutory Reserves

2. Liquidity Reserves

Philippine Monetary/Currency Policy

Bangko Sentral ng Pilipinas
In accordance with Republic Act No. 265, The Bangko Sentral ng Pilipinas or BSP is
the central monetary authority of the Republic of the Philippines. It provides policy
directions in the areas of money, banking and credit and exists to supervise operations
of banks and exercises regulatory powers over non-bank financial institutions. It keeps
aggregate demand from growing rapidly with resulting high inflation, or from growing
too slowly, resulting in high unemployment
The primary objective of BSP's monetary policy is to promote price stability because it
has the sole ability to influence the amount of money circulating in the economy. In
doing so, other economic goals, such as promoting financial stability and achieving
broad-based, sustainable economic growth, are given consideration in policy decision
making.

Philippine Monetary Framework I: 1980s to early 1990s

In the past, the BSP followed the monetary aggregate targeting approach to monetary
policy. This approach is based on the assumption that there is a stable and predictable
relationship between money, output and inflation.
In particular, all money aggregates, with the exception of reserve money, are
incorporated with output and interest rate. This means that there is a long-run
relationship between money on one hand and output and interest rate on the other
so that even if there are shocks in the economy, the variables will return to their
trend equilibrium levels.
This means that changes in money supply (on the assumption that velocity is stable
over time) are directly related to price changes or to inflation. Thus, it is assumed that
the BSP is able to determine the level of money supply that is needed given the
desired level of inflation that is consistent with the economy's growth objective. In
effect, under the monetary targeting framework, the BSP controls inflation indirectly by
targeting money supply

Philippine Monetary Framework II: June 1995 to Present

The BSP employs a modified framework beginning the second semester of 1995
in attempt to enhance the effectiveness of the monetary policy by complementing
monetary aggregate targeting with some form of inflation targeting, placing greater
emphasis on price stability.
Certain key modifications include:

∙ Allows base money levels to go beyond target as long as the inflation rates are met ∙
An excess of one or more percentage points of inflation over the program induces
mopping up operation by the BSP to bring down base money to the previous month's
level
Under an aggregate targeting framework, the BSP fixes money growth so as to
minimize expected inflation. On the other hand, under the new framework, BSP sets
 monetary policy so that price level is not just zero in expectation but is also zero
regardless of latter shocks. Moreover, the framework was changed because BSP
wanted to address the fact that aggregate targeting did not account for the long-run
effects of monetary policy on the economy.
With this approach, the BSP can exceed the monetary targets as long as the actual
inflation rate is kept within program levels and policymakers monitor a larger set of
economic variables in making decisions regarding the appropriate stance of
monetary policy.

Approach: Inflation Targeting

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CENTRAL BANKING Current

As mentioned earlier, Inflation Targeting requires a public announcement of an inflation

rate that a country will target for the coming years, or in a given period of time. It focuses
on maintaining a low level of inflation, that which is considered to be optimal, or at least
would allow the country to have ample economic growth. Its main desire is to achieve
price stability as the ultimate end goal of the monetary policy. The Philippines formally
adopted Inflation Targeting as the framework for Monetary Policy on January 2002.
The Philippines’ inflation target is measured through the Consumer Price Index (CPI).
For 2009, inflation target has been set to be 3.5 percent, having a 1% tolerance level,
and 4.5 percent for 2010, also having 1% tolerance. Also, the Monetary Board of the
Philippines announced a target of around 4±1 percent from 2012 to 2014.

Monetary Policy Issues

Exchange Rate
Exchange rates play a significant role in monetary transmission mechanism and at the
same time, it can have a large impact on inflation rates. Although the BSP has adopted
the inflation targeting approach, it may be tempted to inexplicitly target exchange rate
to achieve its low inflation target. The issue here is the extent of the exchange rate
pass through or ERPT to domestic prices since higher ERPT would require the BSP to
shift its attention to exchange rate movements to stabilize prices.

Role of Monetary Aggregates

Since the shift to inflation targeting, BSP has already abandoned monetary aggregates
because its information content has apparently declined in the recent years. Moreover, it
is also assumed that a shift of approach was necessary because money aggregates are
normally not good indicators of future economic policy requirements due to unreliability
of measurement.

Measurement of Inflation and Liquidity Trap

Since inflation targeting leads to lower and stable inflation rates, more improvement
should then be given to the measurement of the consumer price index since few
percentage points have greater repercussions when rates are low. Errors in CPI
measurement could lead to ineffective and unsuitable monetary policy response by the
BSP which definitely result to detrimental effects to the economy.
Another issue arising from monetary policies is the liquidity trap. This happens when
inflation rate declines too much leading to a threat of deflation. Liquidity trap is defined
as a situation in which there are zero nominal interest rates, persistent deflation and
deflation expectations. In the event this occurs, bonds and money earn the same real
rate of return thus making people indifferent to holding bonds or excess money.
 Budget Deficit and External Debts
Given high budget deficits, the government is concerned about two closely related
issues: it does not want to pay very high interest on its borrowings and it does not want
to crowd out the market. Ideally, the government could raise tax revenues to avoid
borrowing huge sums from the market. However, the government opted to borrow from
the international capital market and though rates are low, these have shorter maturity
and country's outstanding external debt has continued to move towards a less ideal
position.

Fiscal Dominance
According to the fiscal theory of the price level, it is not the non-interest bearing money
but the total nominal liabilities including interest bearing notes and future fiscal surpluses
that matter for price-level determination. In the absence of fiscal discipline, an
independent central bank such as the BSP cannot guarantee a stable nominal anchor.
In other words, for the BSP to successfully focus on price stability, there must be a
credible commitment on the part of the National Government to reduce total fiscal
deficits by a meaningful amount.

MONETARY POLICY AND CENTRAL BANKING

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For more knowledge please follow the link provided;
https://www.youtube.com/watch?v=p-iEl4i5hmk

https://en.wikipedia.org/wiki/Monetary_policy_of_the_Philippines