Philippine Monetary Policy

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. 
The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines. It was
established on 3 July 1993 pursuant to the provisions of the 1987 Philippine Constitution and the New
Central Bank Act of 1993. The BSP took over from Central Bank of Philippines, which was established on
3 January 1949, as the country’s central monetary authority. The BSP enjoys fiscal and administrative
autonomy from the National Government in the pursuit of its mandated responsibilities.
Monetary policy is the policy adopted by the monetary authority of a nation to control either
the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet
their short-term needs) or the money supply, often as an attempt to reduce inflation or the interest
rate, to ensure price stability and general trust of the value and stability of the nation's currency.
Monetary policy is a modification of the supply of money, i.e. "printing" more money, or
decreasing the money supply by changing interest rates or removing excess reserves. This is in
contrast to fiscal policy, which relies on taxation, government spending, and government
borrowing[4] as methods for a government to manage business cycle phenomena such as recessions.
Further purposes of a monetary policy are usually to contribute to the stability of gross
domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange
rates with other currencies.
Monetary economics can provide insight into crafting optimal monetary policy. In developed
countries, monetary policy is generally formed separately from fiscal policy.
Monetary policy is referred to as being either expansionary or contractionary.
 Expansionary policy occurs when a monetary authority uses its procedures to stimulate the
economy. An expansionary policy maintains short-term interest rates at a lower than usual rate
or increases the total supply of money in the economy more rapidly than usual. It is
traditionally used to try to reduce unemployment during a recession by decreasing interest
rates in the hope that less expensive credit will entice businesses into borrowing more money
and thereby expanding. This would increase aggregate demand (the overall demand for all
goods and services in an economy), which would increase short-term growth as measured by
increase of gross domestic product (GDP). Expansionary monetary policy, by increasing the
amount of currency in circulation, usually diminishes the value of the currency relative to other
currencies (the exchange rate), in which case foreign purchasers will be able to purchase more
with their currency in the country with the devalued currency.
 Contractionary policy maintains short-term interest rates greater than usual, slows the rate of
growth of the money supply, or even decreases it to slow short-term economic growth and
lessen inflation. Contractionary policy can result in increased unemployment and depressed
borrowing and spending by consumers and businesses, which can eventually result in
an economic recession if implemented too vigorously.
List of Advantages of Monetary Policy
1. It can bring out the possibility of more investments coming in and consumers spending
more.
In an expansionary monetary policy, where banks are lowering interest rates on loans and
mortgages, more business owners would be encouraged to expand their ventures, as they would
have more available funds to borrow with affordable interest rates. Plus, prices of commodities would
also be lowered, so consumers will have more reasons to purchase more goods. As a result,
businesses would gain more profit while consumers can afford basic commodities, services and even
property.
2. It allows for the imposition of quantitative easing by the Central Bank.
The Federal Reserve can make use of a monetary policy to create or print more money, allowing
them to purchase government bonds from banks and resulting to increased monetary base and cash
reserves in banks. This also means lower interest rates and, eventually, more money for financial
institutions to lend its borrowers.
3. It can lead to lower rates of mortgage payments.
As monetary policy would lower interest rates, it would also mean lower payments home owners
would be required for the mortgage of their houses, leaving homeowners more money to spend on
other important things. It would also mean that consumers will be able to settle their monthly
payments regularly—a win-win situation for creditors, merchandisers and property investors as well!
4. It can promote low inflation rates.
One of the biggest perks of monetary policy is that it can help promote stable prices, which are very
helpful in ensuring inflation rates will stay low throughout the country and even the world. As inflation
essentially makes an impact on the way we spend money and how much money is worth, a low
inflation rate would allow us to make the best financial decisions in life without worrying about prices
to drastically rise unexpectedly.
5. It promotes transparency and predictability.
A monetary policy would oblige policymakers to make announcements that are believable to
consumers and business owners in terms of the type of policy to be expected in the future.
6. It promotes political freedom.
Since the central bank can operate separately from the government, this will allow them to make the
best decisions based upon how the economy is performing doing at a certain point in time. Also, the
banks would operate based on hard facts and data, rather than the wants and needs of certain
individuals. Even the Federal Reserve can operate without being exposed to political influences

List of Disadvantages of Monetary Policy

1. It does not guarantee economy recovery.
Economists who criticize the Federal Reserve on imposing monetary policy argue that, during
recessions, not all consumers would have the confidence to spend and take advantage of low interest
rates, making it a disadvantage.
2. It is not that useful during global recessions.
Proponents of expansionary monetary policy state that even if banks lower interest rates for
consumers to spend more money during a global recession, the export sector would suffer. If this is
the case, export losses would be more than what commercial organizations could earn from their
sales.
3. Its ability to cut interest rates is not a guarantee.
Though a monetary policy is said to allow banks to enjoy lower interest rates from the Central Bank
when they borrow money, some of them might have the funds, which means that there would be
insufficient funds that people can borrow from them.
4. It can take time to be implemented.
With things expected to be done immediately in these modern times, implementing a monetary can
certainly take time, unlike other types of policies, such as a fiscal policy, that can help push more
money into the economy faster. According to experts, changes that are made for a monetary policy
might take years before they begin to take place and make changes felt, especially when it comes to
inflation.
5. It could discourage businesses to expand.
With this policy, interest rates can still increase, making businesses not willing to expand their
operations, resulting to less production and eventually higher prices. While consumers would not be
able to afford goods and services, it would take a long time for businesses to recover and even cause
them to close up shop. Workers would then lose their jobs.
Monetary policy is used in to help keep economic growth and stability, but there is no
guarantee that it would always help society, considering that it also has its own set of drawbacks.

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.[2] This contains all of M1 plus peso saving deposits (money market deposit
accounts), time deposits and balances in retail money market mutual funds.
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 Sentra 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
supply will be observed greatly.
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.

Current Approach: Inflation Targeting

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.
What is a Fiscal Policy?
Fiscal Policy -is the means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a
central bank influences a nation's money supply. These two policies are used in various combinations
to direct a country's economic goals. 
Before the Great Depression, which lasted from October 29, 1929, to the onset of America's entry into
World War II, the government's approach to the economy was laissez-faire. Following World War II, it
was determined that the government had to take a proactive role in the economy to regulate
unemployment, business cycles, inflation, and the cost of money. By using a mix of monetary and
fiscal policies (depending on the political orientations and the philosophies of those in power at a
particular time, one policy may dominate over another), governments can control economic
phenomena.
How Fiscal Policy Works
Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known
as Keynesian economics, this theory basically states that governments can influence macroeconomic
productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn,
curbs inflation (generally considered to be healthy when between 2% and 3%), increases
employment, and maintains a healthy value of money. Fiscal policy plays a very important role in
managing a country's economy. For example, in 2012 many worried that the fiscal cliff, a
simultaneous increase in tax rates and cuts in government spending set to occur in January 2013,
would send the U.S. economy back into recession. The U.S. Congress avoided this problem by
passing the American Taxpayer Relief Act of 2012 on Jan. 1, 2013.

Balancing Act
The idea is to find a balance between tax rates and public spending. For example, stimulating a
stagnant economy by increasing spending or lowering taxes, also known as expansionary fiscal
policy, runs the risk of causing inflation to rise. This is because an increase in the amount of money in
the economy, followed by an increase in consumer demand, can result in a decrease in the value of
money—meaning that it would take more money to buy something that has not changed in value.

Let's say that an economy has slowed down. Unemployment levels are up, consumer spending is
down, and businesses are not making substantial profits. A government may decide to fuel the
economy's engine by decreasing taxation, which gives consumers more spending money while
increasing government spending in the form of buying services from the market (such as building
roads or schools). By paying for such services, the government creates jobs and wages that are in
turn pumped into the economy. Pumping money into the economy by decreasing taxation and
increasing government spending is also known as "pump priming." In the meantime, overall
unemployment levels will fall.

With more money in the economy and less taxes to pay, consumer demand for goods and services
increases. This, in turn, rekindles businesses and turns the cycle around from stagnant to active.

If, however, there are no reins on this process, the increase in economic productivity can cross over a
very fine line and lead to too much money in the market. This excess in supply decreases the value of
money while pushing up prices (because of the increase in demand for consumer products). Hence,
inflation exceeds the reasonable level.

For this reason, fine-tuning the economy through fiscal policy alone can be a difficult, if
not improbable, means to reach economic goals.

Four Major Functions of Fiscal Policy

1. Allocation Function:
The provision for social goods, or the process by which total resource use is divided between private
and social goods and by which the mix of social goods is chosen. This provision may be termed as
the allocation function of budget policy. Social goods, as distinct from private goods, cannot be
provided for through the market system.
The basic reasons for the market failure in the provision of social goods are: firstly, because
consumption of such products by individuals is non rival, in the sense that one person’s partaking of
benefits does not reduce the benefits available to others.

The benefits of social goods are externalised. Secondly, the exclusion principle is not feasible in the
case of social goods. The application of exclusion is frequently impossible or prohibitively expensive.
So, the social goods are to be provided by the government.

2. Distribution Function:
Adjustment of the distribution of income and wealth to assure conformance with what society
considers a ‘fair’ or ‘just’ state of distribution. The distribution of income and wealth determined by the
market forces and laws of inheritance involve a substantial degree of inequality. Tax transfer policies
of the government play an important role in reducing the inequalities in income and wealth in the
economy.

3. Stabilization Function:
Fiscal policy is needed for stabilization, since full employment and price level stability do not come
about automatically in a market economy. Without it the economy tends to be subject to substantial
fluctuations, and it may suffer from sustained periods of unemployment or inflation. Unemployment
and inflation may exist at the same time. Such a situation is known as stagflation.

The overall level of employment and prices in the economy depends upon the level of aggregate
demand, relative to the potential or capacity output valued at prevailing prices. Government
expenditures add to total demand, while taxes reduce it. This suggests that budgetary effects on
demand increase as the level of expenditure increases and as the level of tax revenue decreases.

4. Economic Growth:
Moreover, the problem is not only one of maintaining high employment or of curtailing inflation within
a given level of capacity output. The effects of fiscal policy upon the rate of growth of potential output
must also be allowed for. Fiscal policy may affect the rate of saving and the willingness to invest and
may thereby influence the rate of capital formation.

Capital formation in turn affects productivity growth, so that fiscal policy is a significant factor in
economic growth.

The Bottom Line

One of the biggest obstacles facing policymakers is deciding how much involvement the government
should have in the economy. Indeed, there have been various degrees of interference by the
government over the years. But for the most part, it is accepted that a degree of government
involvement is necessary to sustain a vibrant economy, on which the economic well-being of the
population depends.

Self - Learning Actuvity:

1. List down current monetary and fiscal policy issues of the Philippines.(at least 5 each)
2. Discuss your reaction to each issues (minimum of 150 words for each issues)

Write your answer in a yellow sheet of paper or coupon bond.