Rethinking monetary policy

rethinking monetary policy - Rethinking monetary policy

Bangko Sentral Governor Ben Diokno announced that starting Sept. 18, the BSP will offer P20 billion ($411 million) worth of 28-day bills to the market.

This is a milestone.

We presume that the BSP and the Bureau of the Treasury (BTr) coordinated closely to assiduously define the parameters of their respective issuances. Delineation is important. Plus, care must be taken to avoid crowding out government securities (GS).

Short-term bills with durations of less than 91 days are more appropriate for the BSP’s open market operations in view of the BSP’s primary purpose of inflation management. But the BSP should be flexible to issue longer-dated maturities especially when excessive cross-border capital flows threaten macroeconomic stability.

On the other hand, the National Government’s (NG) development needs are better funded by the Bureau of the Treasury’s (BTr) longer-term issuances.

From 1993 to 2019, the BSP was handicapped by a twist of irony. It was made independent and autonomous, tasked to promote price stability, but it was not authorized by its then Charter, Republic Act (RA) No, 7653, to issue its own debt instruments to regulate domestic liquidity.

Yet under its 1948 charter (RA No. 265), the then Central Bank of the Philippines (CBP) was permitted to issue its own certificates of indebtedness.

In taking away this power from the BSP, Congress was haunted by the CBP’s experience of the mid-1980s. If Congress simply did some due diligence on the whys and wherefores of the Jobo bills, this denial of policy independence could have been avoided.

The domestic inflation rate rose from an average of 10.22% in 1982 to 50.34% in 1984. The peso-dollar rate in those two years depreciated from around P8.50 to a dollar to around P18 to a dollar. FX reserves plummeted as more foreign investors risked off, bringing out their investments somewhere else, and as others decided against entering the local market. Given this extraordinary situation, the CBP issued its own debt securities, the Jobo bills — named after the then CBP Governor Jose “Jobo” B. Fernandez, Jr. — to arrest runaway inflation, sagging FX reserves, and sharp and quick declines in the exchange value of the domestic currency. The debt and balance of payments crises ensued with the debt moratorium. No one wanted to touch Philippine sovereign or corporate credits.

Thus, even as the new BSP was granted independence by RA No. 7653, promoting price stability in the face of both serious supply and demand pressures was a tall order. Its latitude to act was limited to the small volume of GS it could use for open market operations in addition to calibrating the banks’ required reserve ratio (RRR). If money supply became excessive, and many times in the past this was so, the BSP was forced to sell most or all of its holdings of GS to mop it up, and buy back from the secondary market as liquidity and credit conditions would allow. With limited supply of GS, the BSP relied more and more on the RRR despite its bluntness as an instrument.

This was also the reason why the BSP resorted to special deposit accounts (SDAs) and more recently, the term deposit facility (TDF). The SDAs were an offer to banks to deposit their money with the BSP at predetermined interest rates. This was an effective way of bringing excess money to the BSP and helped promote suitable liquidity conditions. But this strategy was far from market-determined. To address increasing interest rate volatility and to offer a more market-driven interest rate determination, the BSP introduced the interest rate corridor system in 2016. Three tenors of the TDF were introduced: seven, 14, and 28 days. However, like the SDAs, they were not negotiable and unable to deepen the capital market.

Perhaps very few in the national bureaucracy and the legislature realized that these monetary policy instruments were not always optimal. It was clear though that in those years, the BSP succeeded in stabilizing price levels, keeping the peso broadly competitive, and was ensuring comfortable FX reserves. When the peso depreciated, the BSP still made money and continued to remit taxes and dividends to the National Government. Ergo, the view was that the BSP did not need additional powers, its charter was well and good, and amendments were not needed.

But indeed, there is such a thing as optimal performance.

We believe the BSP could have surpassed itself in the last 27 years if it had been given the same authority and privileges its new charter now extends to it. With the recent authority to require both public and private entities to submit data and statistics, the BSP can better monitor the macroeconomy and the financial system, conduct more effective surveillance and craft early warning systems and modes of risk management. A hundred-percent government-owned, the BSP is now tax-free in carrying out all its governmental functions. Before, it was required to pay taxes to its sole stockholder in addition to remitting dividends when it made money. The law also formalized the BSP’s responsibility to promote financial stability alongside its primary function of keeping prices stable consistent with economic growth and employment. Its regulatory power now extends to the country’s payments and settlement system. Its scope of supervision and regulation was also expanded to include more financial entities. It now has senior claims on closed banks unlike before when only PDIC enjoyed preference.

In addition, one important provision could be a game changer. The new charter increased the authorized capital base of the BSP from P50 billion to P200 billion. This is payable through an offset against its dividends until the whole amount is fully settled. An adjustment in BSP’s capitalization is many times more imperative given the evolution in size and complexity of the Philippine economy and financial system for the last three decades.

This deep dive into central banking makes it clear that these amendments were at least 20 years behind, considering that the first serious crisis to hit the Philippines was the Asian financial crisis of 1997-98. It was during this period that monetary targeting was hamstrung by the weakening link between monetary aggregates on one hand, and income and inflation on the other hand. The money multiplier started to mutate with the early introduction of new technologies in money and banking. Drastically changing were the structure and dynamics of the Philippine economy and the financial system. With globalization and cross border flows of capital and sustained progressive policy and structural policies revising the financial landscape, the monetary policy framework had to be reworked and refocused for greater effectiveness.

Thus was born the inflation targeting framework in 2002. Between 2002 and 2020, a period of 18 years, the BSP pursued monetary policy with a more appropriate framework, but with its hands tied to RRR and partial open market operations capability.

After the Global Financial Crisis (GFC) of 2007-2009, there was a new twist. Price stability was no longer considered sufficient to ensure financial stability and to sustain economic growth. If the financial system is shaky, stable prices would not be enough to ensure macroeconomic and financial resiliency.

The US Fed, Band of Japan, and the European Central Bank pioneered their own respective versions of unconventional monetary policy. Quantitative easing flooded the market with liquidity through debt purchases, coupled with zero or negative interest rates to restart moribund economies.

While many central banks have yet to consider GFC lessons in their monetary frameworks, COVID-19 surged across the globe, freezing the global economy. Indeed, to the IMF, this crisis is like no other. Both fiscal and monetary authorities have combined forces to prop up their sagging economies.

Can monetary policy help in a meaningful way beyond pushing on a string?

As we pointed out in the past, Charles Goodhart of the London School of Economics observed that the pandemic has caused monetary growth to surge due to a precautionary demand for liquidity. This is the so-called “dash for cash,” embodied in higher public sector deficits and in central banks’ highly accommodative monetary policies.

A monetarist interpretation is that we are setting the stage for a definite spiral in inflation sometime in the near future.

Goodhart quickly pointed out two possible reasons why this might not happen. The velocity of money is declining as quickly as the total money supply is expanding. Due to lockdowns, people are not consuming. Rather, they are conserving cash. Central banks could reverse the expansion of money supply in progress.

Yet, it was also Goodhart who cautioned that people cannot save forever. Shops and restaurants will reopen. People will be rehired. Inflation will stage a comeback. Central bank policy reversals might stress out debt markets when both governments and corporates are in a tight financial bind. The pressure to keep interest rates low, and liquidity flowing, could be overpowering.

Elsewhere, globalization appears to be back pedaling. There is an emerging inward-looking trade policy. This is expected to disrupt supply chains and strengthen labor power. With increasing levels of uncertainty, and weak market confidence, competitive forces could be undermined.

It will be wise therefore to watch how inflation will behave as the pandemic wears off and economic activity gains more traction. Monetary instruments like the BSP’s own debt securities are important. However, at some point, it is no less than monetary policy itself that may have to be reworked.


Diwa C. Guinigundo is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.

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