The Evolution of the Philippine Monetary Policy

I. Introduction

* The chief monetary authority of the Philippines is the Bangko Sentral ng Pilipinas or BSP. Bangko Sentral ng Pilipinas, established in June 1948, is considered as the main monetary authority of the Philippines because it acts as a policy guide to the direction of money, banking and credit. It is here to control operations of banks and implements administrative powers over non-bank financial institutions. It manages aggregate demand from growing fast causing high inflation, or from increasing too sluggishly that would result to high unemployment.

The main aim of BSP is to stimulate price stability since it has power over the circulation of money in the economy.

The policy-making group of BSP was the Monetary Board in 1991. It comprises of the governor of the Central Bank as chairman, the secretary of finance, the director general of the National Economic and Development Authority (NEDA), the chairman of the Board of Investment, and three members from the private sector. BSP controlled the marketable banking arrangement and the country's foreign currency system to achieve its functions.

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* Severe recessions occurred in the modern macroeconomic history of the Philippines. Especially in the 1980s and 1990s, the contemporary macroeconomic history of the Philippines has been manifested by periodic balance of payment dilemmas together with immense devaluations that result in high inflation. As a prerequisite for the discharge of emergency funds, severe monetary and fiscal programs were employed by the IMF that followed these issues.

* A supply gap, domestic saving averaged 25 percent of GNP which was about 5 points in percent less than the yearly gross domestic capital formation, was occupied with foreign capital from 1975 to 1982.

* On the average, GNP’s domestic saving proportion decline between 1893 and 1989. The weakening of domestic saving during this span was due to the effect of the economic dilemma on personal savings that progresses more because of poor government saving. This also led to the deterioration of investment, which only means that for three years span, gross investment was surpassed by domestic savings.

* BSP interfered widely in the country’s financial life starting from the moment it created operations until the early 1980s. When modified for inflation, interest rates on both bank deposits and loans were set negative. Through a widespread system of rediscounting, central bank was stretched to commercial banks. With BSP’s assistance in the 1970s, the banking system decided to choose foreign credit on agreements’ that in general, disregarded foreign-exchange risk.

The association of these factors alleviated against the expansion of financial intermediation in the economy, the increase of long-term saving in particular In 1980s, the contributing financial factors to financial chaos is the reliance of the banking system on funds from BSP at low interest rates.

II. Body

* In the beginning of the 1980s, the government presented a number of monetary measures to augment the banking production's capacity to offer adequate amounts of long-term finance. Through promising mergers and consolidations, efforts were applied to increase the gap of capital base of banks. To augment the competence of the banking industry and to improve the inflow of long-term saving, unibanks or expanded commercial banks was established. Banks with a capital base exceeding P500 million were considered as qualifying banks which were allowed to develop their operations into a variety of new activities, merging commercial banking with activities of investment houses. This functional partition among other groupings of banks was condensed, wherein rural banks and thrift banks were eliminated.

* In the early 1980, the government implemented monetary and fiscal policies to subsidized huge intermediation margins that pertain to the difference between lending and borrowing rates. BSP sustained comparatively high reserve requirements in excess of 20 percent. For example, in 1988, 16.8 percent was the averaged of loan rates wherein rates on savings deposits were only somewhat further than 4 percent. But in 1990, revision of the reserve requirement was done proportionally twice, from 21 to 25 percent. Furthermore, both a 5 percent gross tax on bank receipts and a 20 percent tax on deposit earnings were levied by the government to aid budget deficits and to absorb excess growth in the money supply.

* By January 1983, all interest rate ceilings had been obliterated due to the liberalization of interest rates. Since interest rate ceilings were abolished, rediscounting privileges were decreased and rediscount rates were correlated to the cost of competing funds. The initial response seemed positive but despite that, in the long run, there were variations in the ratio of the country’s money supply. Primarily, his comprises of savings and time deposits to GNP that was around 0.2 in the 1970s to 0.3 in 1983. Soon, it cut down to 0.2 again in the late 1980s, the lowest ratio in Southeast Asia..

* Under the supervision of IMF, money targeting was employed in the Philippines as the first monetary framework.

Monetary targeting is applying an intense monetarist thinking supported by IMF. This approach is grounded on the supposition that there is a steady and likely connection between money, output and inflation. On the whole, it is believed as subsidizing to the complexity of declines in the Philippines in the last 25 years. There is a long-run relationship between money and output with interest rate which makes the economy return to their equilibrium state even if it experiences shocks. This only means that changes in the money supply is directly proportional to inflation or price changes. BSP is expected to identify the level of money supply that is needed with the anticipated level of inflation that is dependent with the growth of the economy. With that being said, BSP indirectly controls inflation by targeting money supply.

* Philippine banks presented considerably diverse rates for deposits of different amounts. In 1988, the interest rates on six-month time deposits of huge depositors averaged almost 13 percent while small savers only got to earn only 4 percent on their savings. There was a 1 percentage difference between the rates offered on six-month and twelve-month time deposits. This was also the same with the difference between foreign currency deposits of all available maturities.

There was high probability interest rate discrimination by the marketable banking industry between minor, less-informed depositors and more affluent savers since savings deposits accounted for almost 60 percent of aggregate bank deposits and substitutes for small savers. To ease capital flight, interest rates were bid up. The Philippine economists and the World Bank charged the Philippine commercial banking industry as highly oligopolistic due to the discrimination joined with the big intermediation margins.

* In attempt to improve the efficacy of the monetary policy, BSP implements a modified framework from June 1995. Supplementing monetary aggregate targeting with some form of price increase targeting, BSP implements a modified framework to improve the effectiveness of the monetary policy in applying greater importance on price stability. The main key modifications include: a. permits base money levels to go outside target as long as the inflation rates are met; b. an excess of one or more percentage points of inflation over the program prompts wiping up procedure by the BSP to convey down base money to the previous month’s level.

With aggregate targeting framework, the BSP repairs money growth so as to reduce expected inflation. In contrast, with the new framework, the monetary policy is set to the price level where it is not zero and zero in expectation, not including latter shock. However, the policy was further modified due the fact that aggregate targeting did not account f or the long-run effects of monetary policy on the economy.

Through this, BSP can surpass the monetary targets as long as the actual inflation rate is maintained within program levels and policymakers observe a greater set of economic variables in creating decisions about the suitable stand of monetary policy.

* The Philippines officially implemented Inflation Targeting as the framework of monetary policy. Since January 2002, the Philippines officially adopted Inflation Targeting as the framework of Monetary Policy. This involves a public declaration of an inflation rate that a country will aim to target for the next years, or in a given period of time. It emphasizes on sustaining a minimal level of inflation, which is considered to be ideal or at least would permit the country to have abundant economic growth. Its main goal is to attain price stability as the final end goal of the monetary policy.

* Through Consumer Price Index, the Philippines’ inflation target is measured.

III. Conclusion

* Throughout the years, the Philippine monetary policy encountered a lot of difficulties and here are the major issues that continue to prevail. Exchange rates have a huge influence on inflation rates and play an important role in monetary transmission. Even though BSP chose to apply the inflation targeting approach, it may be lured to inexplicitly target exchange rate to accomplish its low inflation target. This dilemma is the degree of the exchange rate pass-through to domestic prices since having a high level would oblige BSP to shift its attention to the stabilization of prices through exchange rate movements.

After transferring to inflation targeting, monetary aggregates were not utilized by the BSP anymore since its statistical data has seemingly deteriorated in the recent years. It is also expected that a shift of approach was essential because of the fact that money aggregates are not good indicators of impending economic policy necessities due measurement inaccuracy.

Inflation targeting aids in achieving lower and stabilize inflation rates. Thus, the consumer price index should be enhanced since having few percentage points have greater consequences when rates are low. Having inaccuracies in the CPI measurement could lead to inappropriate and ineffective monetary policy response by the BSP which can be disadvantageous for the aggregate economy.

Liquidity trap is also an issue arising from monetary policies when the inflation rate deteriorates too much that causes a threat of deflation. It is a situation where zero nominal interest rates, persistent deflation and deflation expectations are present. When this happens, bonds and money receive a similar real rate of return that makes people indifferent towards keeping bond or excess money.

The government is concerned about paying high interest on its borrowings and crowding out in the market given high budget deficits. To elude borrowing huge sums from the market, the government could increase tax revenues. Despite that, the government chose to borrow from the international capital market. Even though, rates are minimal, these have smaller maturity and the continuance of the country’s outstanding external debt to move to a less ideal location.

To identify the price-level, the factors that matter are not the non-interest bearing money but the aggregate nominal liabilities that is comprises with bearing notes and future fiscal surpluses based on the fiscal theory of price level. Without this policy discipline, there is no assurance that the BSP can maintain a stable nominal anchor. It basically means that a trustworthy commitment on the part of the National Government is needed to successfully emphasize on price stability to reduce aggregate fiscal deficits by a large portion.