ppt- bsp econ 151

The BSP’s Conduct of The BSP’s Conduct of

Monetary Policy Monetary Policy

ZENO RONALD R. ABENOJADirector

Economic and Financial Learning CenterUniversity of the Philippines Manila

13 July 2011

OUTLINE

A.A. IntroductionIntroduction

B.B. InflationInflation andand PricePrice StabilityStability

C.C. MonetaryMonetary PolicyPolicy andand InflationInflation TargetingTargeting

D.D. InflationInflation:: RecentRecent TrendsTrends andand OutlookOutlook

E.E. ContemporaryContemporary issuesissues inin MonetaryMonetary PolicyPolicy

The BSP : Guardian of price stabilityThe BSP : Guardian of price stability

The primary objective of the

Bangko Sentral is to maintain

price stability conducive to a

balanced and sustainable

growth of the economy. -Sec. 3, RA 7653

(New Central Bank Act)

The BSP formulates and implements monetary

policy consistent with its price stability objective.

OUTLINE






Price stability

• “An environment in which inflation is

sufficiently low that it is no longer a

consideration in the economic decisions of

households and firms” – Alan Greenspan

• “Prices are stable when ordinary people stop

talking about inflation.” - Alan Blinder

What is price stability?What is price stability?

What is price stability?What is price stability?

Price stability

• On average, prices

neither increase

nor decrease

markedly

• There is low and

stable inflation

What is inflation? What is inflation?

Inflation

• sustained increase in the

average prices of goods and

services typically purchased by

consumers

• measured as the annual

percentage change in the

Consumer Price Index

How are prices measured? How are prices measured?

CPI

• represents the average price

of a standard basket of

goods and services

consumed by a typical

Filipino family for

a given period

Positive rate of change in CPI =

Inflation Rate

What causes inflation? What causes inflation?

Prices increase when…

Changes in price level result from interaction of

supply and demand.

• Supply < Demand

• Demand > Supply

Prices decrease when…

• Supply > Demand

• Demand < Supply


Types of inflation

Cost-push

• Due to increase in cost of

production and other

supply factors (e.g.,

weather disturbances,

increase in world oil prices)

• Outside the influence of BSP


Types of inflation

Demand-pull

• Due to excess demand relative to supply of goods

and services (e.g., increase

money supply)

• BSP exerts influence over

money supply and thus can

control inflation

High

and

volatile

inflation

Distorts economic decisions:

• consumption• saving• investment• production

Inefficient allocation

of resources

Slower

economic

growthLower confidence in financial instruments as a form of savings

Negative effects on

income distribution

Loss of purchasing

power

Impact of high inflation on the economy

Why is price stability important?Why is price stability important?

OUTLINE






PRICE STABILITY

to a

ttain

Actions by a central bank to manage the

availability and cost of money and credit to attain stable prices

Price of

Money and Credit

Level of

Money and Credit

Level of

Money and Credit

What is Monetary Policy?What is Monetary Policy?

Monetary Policy

Actions by a centralbank to manage theavailability and costof money and creditto attain stable prices

Refers to the

level of money or

credit supply

which a central

bank can directly

control

Level of

Money and Credit

Level of

Money and CreditMonetary Policy


Actions by a centralbank to manage theavailability and costof money and creditto attain stable prices

Refers to the

“price” of savings/

investment which

influences how

much and where

money goes

Price of

Money and Credit

Monetary Policy

Level of

Money and Credit

Level of

Money and Credit


Monetary

Policy

Level of

Money and Credit

Price of

Money and Credit

PRICE STABILITY

to a

ttain

Quantity

instruments

Price

instruments

What are the tools of Monetary Policy?What are the tools of Monetary Policy?


Monetary Policy instruments

Quantity

instruments

• control directly the availability

or level of loanable funds (e.g., reserve requirements,

rediscounting)

Price

instruments

• influence the rate of return on

financial instruments(i.e., RRP and RP rates)

1. Open market operations (OMO) - involves the buying

and selling of government securities from/to the public

as well as repurchase and reverse repurchase

agreements (the RP/RRP rate is the main policy

instrument)

To liquidity Reduce RRP rates or

Purchase of GS

Market/

BSP will

release

money into

the system

20

Raise RRP rates or

Sale of GS

Market/

BSP will

siphon off

money from

the system

To liquidity


Monetary Policy instruments

2. Reserve Requirement – amount of money/liquid

assets that banks are required to keep in their

vaults or deposit with the BSP

To liquidity Lower RR

Banks have

more money

for lending

& investments

To liquidity Raise RR

Banks have

less money

for lending

& investments


3. Rediscounting facility – a BSP facility that provides

refinancing for banks for credits extended to the

private and public sectors

• To contract or expand liquidity in the financial

system, the BSP can increase/decrease the

rediscount rate (pegged to the policy rate) or

decrease/increase the rediscounting budget


Banks are

encouraged

to refinance

loans with BSP

To liquidity

Increase

rediscounting

budget/

reduce

policy rate

(accordingly,

rediscounting

rate is also

reduced)

Banks tend

to reduce

excess

reserves;

cheaper to

refinance

loans

What are the tools of monetary policy?What are the tools of monetary policy?

Rediscounting facility

Banks are

discouraged

to refinance

loans with BSP

To liquidity

Reduce

rediscounting

budget/

increase

policy rate

(accordingly,

rediscounting

rate is also

increased)

Banks tend

to raise

excess

reserves;

more costly

to

refinance

loans

Rediscounting facility

What are the tools of monetary policy?What are the tools of monetary policy?

4. Special Deposit Account (SDA) facility - a BSP deposit

facility for banks and trust entities of BSP-

supervised financial institutions

• To contract or expand liquidity in the financial

system, the BSP can encourage/discourage

deposits in the SDA by increasing/decreasing

the RRP rate (since the SDA rate is pegged to the

policy rate)


Consumption

Investment

Government

Spending

Exports

Imports

Quantity

instruments

Price

instruments

Affect

Total Aggregate Demand

Inflation

How does Monetary Policy affect prices?How does Monetary Policy affect prices?

Monetary Policy manages inflation by influencing aggregate demand and hence, output growth in the economy.

CreditCredit

ExpectationsExpectationsNet Net

externalexternal

demanddemand

Exchange Exchange

raterate

Import Import

pricesprices

Asset pricesAsset prices

SupplySupply

Stage 3Stage 1 Stage 2

15-21 months

Total Total

demanddemand

Domestic Domestic

inflationary inflationary

pressurepressure

Domestic Domestic

demanddemand

INFLATIONINFLATION

Interest Interest

RateRate

POLICY POLICY

INSTRUMENTSINSTRUMENTS

How does Monetary Policy affect prices?How does Monetary Policy affect prices?

Transmission channels – how monetary policy

affects price and real variables

• Involves the central bank

publicly announcing an

inflation target which it promises to achieve over a certain period

• Formally adopted by the BSP in January 2002 as its monetary policy framework

Inflation targeting

What is the BSP’s Monetary Policy framework?What is the BSP’s Monetary Policy framework?

• Is forward-looking

• Reflects a comprehensive approach to policy by taking into consideration the widest set of available information about the economy

• Increases accountability of the BSP and helps build credibility

• Promotes transparency in monetary policy

Why did the BSP adopt IT?Why did the BSP adopt IT?

Inflation targeting

• Set a target inflation rate - explicit inflation targets for some period ahead

• Forecast the future path of inflation - using a model that uses relevant variables and information indicators

• Compare forecast with the target

• Difference determines the extent that monetary policy has to be adjusted

How does inflation targeting work?How does inflation targeting work?

Inflation targeting: essential elements

Government sets Government sets

inflation target 2 years in advance inflation target 2 years in advance

(in consultation with BSP)(in consultation with BSP)

2011: 4.0% 2011: 4.0% ++ 1 1 pptppt

2012: 4.0% 2012: 4.0% ++ 1 1 pptppt

BSP announces BSP announces

inflation target (yearly)inflation target (yearly)

BSPBSP

•• Assesses economic conditionsAssesses economic conditions

•• Forecasts inflationForecasts inflation

•• Conducts monetary policyConducts monetary policy

Is inflationIs inflation

forecast inforecast in

line withline with

target? target?

BSPBSP

•• Adjusts policy ratesAdjusts policy rates

•• Issues Open letter to the Issues Open letter to the

President (yearly)President (yearly)

BSPBSP

•• Publishes highlights of MB Publishes highlights of MB

meetings on monetary policy meetings on monetary policy

discussionsdiscussions

•• Publishes Inflation ReportPublishes Inflation Report

•• Releases press statementReleases press statement

YESYES

NONO

FORWARD-

LOOKING

COMPREHENSIVE

INCREASES

ACCOUNTABILITY

PROMOTES

TRANSPARENCY

Inflation targeting: framework Inflation targeting: framework


Data disclosure and policy communication

• Quarterly inflation report - serves as a monetary policy statement

• Press releases at the time of monetary policy decision - done every six weeks

• Highlights of the meeting of the Monetary Board on monetary policy - lag of four weeks

• Speeches by the Governor and other senior BSP officials - public presentations and information campaign.

• Open letter addressed to the President of the Philippines.


Circumstances when the BSP is not held accountable for deviations from inflation target

• High prices of agricultural products

• High prices of oil products

• Significant government policy changes that directly affect prices (e.g., new taxes and subsidies)

• Natural disasters and calamities affecting major sectors of the economy


BSP’s explanation clauses

• Establishment of point target– Prior to 2008, inflation targets were given by a range

(ex: Inflation target 2007: 4-5%)

• Establishment of medium-term inflation target– Beginning 2010, BSP announces a medium-term inflation

target to help anchor inflation expectations

Recent developments in BSP’s IT framework


Inflation target for 2011: 4.0 + 1.0%

Inflation target for 2012-2014: 4.0 + 1.0%

OUTLINE






0

5

10

15

20

25

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 11-Jan

Headline inflationHeadline inflationYearYear--onon--year change in percent (2000=100)year change in percent (2000=100)

2010 ave. = 3.8%

2011 YTD ave. = 4.3%

Oil price hike, peso

depreciation, natural calamities (e.g.

earthquakes)

Rice crisis

Asian financial

crisis, El Niño Oil

price hike

Power

crisis

Peso

depreciation, oil price hike RVAT

Inflation

Targeting

Oil price hike and

rise in prices of agricommodities

How has inflation behaved over the years?How has inflation behaved over the years?

June 2011

4.6%

YearActual Inflation(in percent)

Inflation Target(in percent)1

2002 2.9 4.5 −−−− 5.5

2003 3.0 4.5 −−−− 5.5

2004 5.5 4.0 −−−− 5.0

2005 7.6 5.0 −−−− 6.0

2006 6.2 4.0 −−−− 5.0

2007 2.8 4.0 −−−− 5.0

2008 9.3 4.0 ±±±± 1.0

2009 3.2 3.5 ±±±± 1.0

2010 3.8 4.5 ±±±± 1.0

2011 4.3 YTD as of June 4.0 ±±±± 1.0

Notes:

* For 2002-2004, actual inflation

figures are 1994-based while

data for 2005-2008 are 2000-

based1 Annual target

How has inflation performed visHow has inflation performed vis--àà--vis targets?vis targets?

What is the outlook for inflationWhat is the outlook for inflation??

Latest inflation forecasts indicate a manageable

inflation environment over the policy horizon.

* Source: BSP Inflation Report Q1 2011

Although inflation pressures have moderated

slightly, the inflation target remains at risk.

What is the outlook for inflation?What is the outlook for inflation?

Upside risks

• Higher global food and oil prices

• Potential adjustments in domestic rice prices and electricity charges

• Potential impact of weather disturbances on agricultural production

Downside risks

• Sustained appreciation of the peso

• Weaker global recovery

OUTLINE






Multispeed global recoveryMultispeed global recovery

Source: IMF World Economic Outlook Update, April 2011

Two-speed global recovery :

� Emerging and developing

market economies to

expand by 6.5 percent in

2011

� Advanced economies to

grow by 2.5 percent

42

•• Uncertainty of external demand poses risks to the Uncertainty of external demand poses risks to the

economic outlookeconomic outlook

• Slow recovery scenario for global growth in the US

and other advanced economies given:

• Uncertainties in global financial markets

• Possible withdrawal of stimulus

• Impact of high commodity prices

• Possibility of default of some member in the Euro

region

Multispeed global recoveryMultispeed global recovery

Drivers in the acceleration of

cross-border capital flows:

• Brighter growth prospects in

emerging market (EM) economies

• Accommodative monetary policies

in advanced economies (AE)

• Yield differentials favoring EMs

• Improved risk appetite for EM

assets

Large capital inflowsLarge capital inflows

IMF REO for Asia (Oct, 2010): “growth and strong

macrofundamentals are the driving force behind the inflows;

interest rates and yield differentials provide an ancillary role”

Credit take-up has been moderate, with loan growth at pace

with the expansion in economic activity

If current conditions of

strong external liquidity

continue, these could

add to market volatility

Managing these flows

will test the

effectiveness of central

bank policies

There is also a risk that

flow of capital would

reverse quickly, leading

to costly sudden stops


0

500

1,000

1,500

2,000

2,500

3,000

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Liquidity and Bank Lending

Jan 2002 – April 2011; in Php billion

Domestic Liquidity - lhs

Bank Lending (Net of RRPs) - rhs

Policy toolkit Policy toolkit 1.1. Improved monitoring of capital inflows Improved monitoring of capital inflows

2.2. Greater exchange rate flexibilityGreater exchange rate flexibility

3.3. Reserve accumulation and associated liquidity Reserve accumulation and associated liquidity

management operations management operations

4.4. Financial sector reforms to deepen financial markets Financial sector reforms to deepen financial markets

5.5. MacroprudentialMacroprudential measures to strengthen banking measures to strengthen banking

system healthsystem health

6.6. Reform of the FX regulatory framework to encourage Reform of the FX regulatory framework to encourage

outflowsoutflows

7.7. Prepayment of external debtPrepayment of external debt

8.8. Careful communication to markets about central bank Careful communication to markets about central bank

views/responsesviews/responses

9.9. Calibrations in monetary policy, when necessaryCalibrations in monetary policy, when necessary


The asset price debate: should monetary policy try to burst the bubble?

� The BSP does not actively respond to asset price bubbles

� But continues to be highly attentive and alert to credit growth, asset price movements and imbalances

� BSP uses variety of macroprudentialinstruments to temper asset price escalations

Asset price bubblesAsset price bubbles

47

Asset price bubblesAsset price bubbles

Limited evidence of stretched asset market valuations

0

20,000

40,000

60,000

80,000

100,000

120,000

1Q

'01

2Q 3Q 4Q

1Q

'02

2Q 3Q 4Q

1Q

'03

2Q 3Q 4Q

1Q

'04

2Q 3Q 4Q

1Q

'05

2Q 3Q 4Q

1Q

'06

2Q 3Q 4Q

1Q

'07

2Q 3Q 4Q

1Q

'08

2Q 3Q 4Q

1 Q

'09

2Q 3Q 4Q

1 Q

'10

2Q 3Q 4Q

1 Q

'11

Average Land Values, Makati CBD and Ortigas

Real Prices, based on rebased CPI (in pesos per square meter)

Makati Ortigas

Q1 2011:

P83,921/sq.m

Q1 2011:

P38,782/sq.m

0

100

200

300

400

500

600

700

1Q

'01

2Q

3Q

4Q

1Q

'02

2Q

3Q

4Q

1Q

'03

2Q

3Q

4Q

1Q

'04

2Q

3Q

4Q

1Q

'05

2Q

3Q

4Q

1Q

'06

2Q

3Q

4Q

1Q

'07

2Q

3Q

4Q

1Q

'08

2Q

3Q

4Q

1 Q

'09

2Q

3Q

4Q

1 Q

'10

2Q

3Q

4Q

1 Q

'11

Office and Residential Rental Values

Real Prices, based on rebased CPI (in pesos per square meter per month)

Residential Rental Values Office Rental Values

Q1 2011:

P351/sq.m

Q1 2011:

P239/sq.m

7

9

11

13

15

17

19

21

23

25

27

29

31

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

PRICE-EARNINGS (P/E) RATIO

May 2011 = 15.32

50

70

90

110

130

150

170

190

210

230

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Major Trading Partners = 85.58 (May 2011)

Broad = 136.23 (May 2011)

EFFECTIVE EXCHANGE RATE INDICES OF THE PESO

Narrow = 171.99 (May 2011)

� In Asia, recent bout of

inflation being stoked by

higher costs of food and oil

� Escalating prices are

complicating trade-off

between keeping a lid on

prices and sustaining

growth

� Why should we be

concerned?

-Erodes purchasing power

-Could force policy

tightening

48

Commodity price increaseCommodity price increase

0

50

100

150

200

250

0

20

40

60

80

100

120

140

Jan 2

00

7F

eb

Ma

rA

pr

May

Jun

Jul

Au

gS

ept

Oct

Nov

Dec

Jan 2

00

8F

eb

Ma

rA

pr

May

Jun

Jul

Au

gS

ept

Oct

Nov

Dec

Jan 2

00

9F

eb

Ma

rA

pr

May

Jun

Jul

Au

gS

ept

Oct

Nov

Dec

Jan 2

01

0F

eb

Ma

rA

pr

May

Jun

Jul

Au

gS

ep

Oct

Nov

Dec

Jan 2

01

1F

eb

Ma

rA

pr

May

Dubai Crude Prices (US$/barrel) FAO Food Price Index (FPI)

FPIMay 2011

232

Global Food Price Index and Dubai Crude Oil Prices

2007 -May 2011

FPIJun 2008

224.13

FPIApr 2011

235

49

Country Food Weight

Myanmar 68.3

Nepal 53.2

Philippines 46.6

Sri Lanka 45.5

Cambodia 42.7

Mongolia 41.1

Papua New Guinea 40.9

Indonesia 36.0

Fiji 35.4

Thailand 33.0

Malaysia 30.0

China 26.9

Taiwan 26.0

Singapore 22.1

Brunei Darussalam 17.1

India* 14.3

Korea, Rep 14.0

*WPI

Source: CEIC, official statistic website, and Bloomberg

Country Energy

Weight

(in

percent)

Singapore 21.0

Indonesia 15.0

Thailand 15.0

Malaysia 15.0

China 15.0

Korea, Rep 15.0

India 14.0

Philippines 10.0

Taiwan 7.0

Source: Nomura

• Share of food to

the consumption

basket is higher

than those in

some neighboring

countries


50

Compared with neighboring countries, recent Philippine food inflation is one of the lowest


-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Jan

-08

Ap

r-0

8

Jul-

08

Oct

-08

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Indonesia

Malaysia

Thailand

Philippines

Vietnam

Year on year inflation of selected countriesJanuary 2008 – May 2011

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Jan

-08

Ap

r-0

8

Jul-

08

Oct

-08

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Indonesia

Malaysia

Thailand

Vietnam

Philippines

Year on year food inflation of selected countriesJanuary 2008 – May 2011

Some reasons why food inflation is lower in the Philippines

Favorable domestic supply conditions…Timely importation of rice and sugar

Recovery of agriculture in Q4 2010 sustained into 2011

…while neighboring countries have faced supply constraints

Malaysia: food inflation affected by subsidy rationalization program

South Korea: foot and mouth disease affected meat prices

Extreme weather conditions in parts of Asia:

Source: FAO Crop Prospects and Food Situation December 2010

Country Impact on Food Inflation

India Unseasonal rains in some parts of the country disrupted vegetable

output

Indonesia Extreme weather disrupted harvests and food distribution

South Korea Heavy snow and unusually cold weather affected vegetable supply

China Cold spring delayed planting and damaged vegetable crops; rising labor

costs also pushed up the price of agricultural products


Country Weight of Rice in CPI Basket

Philippines 9.36

India 1.79

Indonesia 5.80a/

Thailand 2.88b/

a/Includes paddy, tubers and their products

b/Refers to weight of rice, flour, and cereal products


• Well-behaved rice prices• Timely importation of rice augmented by domestic production

brought inventory to record levels in recent months

• Domestic rice production in Q4 2010 recovered, growing by

21.1 percent compared to -24.8 percent in Q3

• Corn production also recovered by 13.8 percent

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Indonesia Thailand Malaysia South Korea India Philippines

Q1 2010 Q2 2010 Q3 2010

PCE Growth (YoY, %)

Source: Bloomberg

0

5

10

15

20

25

Indonesia Thailand Malaysia South Korea India Philippines China

Q1 2010 Q2 2010 Q3 2010 Q4 2010

Growth in Liquidity (YoY, %)

Source : Bloomberg

Data for Indonesia, Thailand and China refer to M2 growth rates


Stronger private demand & liquidity growth in some Asian countries compared to

relatively moderate growth in PHL

IMF Projections for Consumer Prices

Advanced

Economies

Emerging and

Developing

Economies

2009 0.1 5.2

2010 1.6 6.2

2011 2.2 6.9

2012 1.7 5.3

Source: IMF WEO Update, April 2011

Commodity Price Increase: Persistent? Commodity Price Increase: Persistent?

�Upside pressures on commodity prices expected to persist in 2011 and 2012 due to :� strong global demand� supply disruptions and

sluggish supply response

� Inflation pressures more pronounced in emerging and developing countries

54

Financial stability dimension of price stability

� Price stability: necessary but not sufficient to achieve financial stability

� Emergence of imbalances even when monetary policy settings appear appropriate

� Best approach is to involve a portfolio of instruments with macroprudentialregulation

Financial stabilityFinancial stability

The BSP’s Conduct of The BSP’s Conduct of

Monetary Policy Monetary Policy

ZENO RONALD R. ABENOJADirector

Economic and Financial Learning CenterUniversity of the Philippines Manila

13 July 2011

ppt- bsp econ 151

Economy & Finance