PART 2 - PHILIPPINE MONETARY POLICY

MONETARY POLICY
Thus, monetary policy, according to G. K. Shaw, refers to any deliberate and conscious action
undertaken by the central monetary authority “to change the quantity, availability or cost
(interest rate) of money.

Monetary policy involves the influence on the level and composition of aggregate demand by the manipulation of interest
rates and the availability of credit”-D.C. Aston.

Monetary policy implies those measures designed to ensure an efficient operation of the economic system or set of
specific objectives through its influence on the supply, cost and availability of money.

The concept of monetary policy has been defined in a different manner according to different economists;

R.P. Kent has defined the monetary policy as “The management of the expansion and contraction of the volume of money
in circulation for the explicit purpose of attaining a specific objective such as full employment.”

According to Prof. Crowther, “Monetary Policy consists of the steps taken or efforts made to reduce to a
minimum the disadvantages that flow from the existence and operation of the monetary system. It is a
policy to regulate the flow of monetary resources in the economy to attain certain specific objectives.”

D.C. Aston has defined:”Monetary policy involves the influence on the level and composition of aggregate
demand by the manipulation of interest rates and the availability of credit.”

Since monetary policy can influence the rate of interest, investment, and the availability of credit, it can
direct aggregate savings in the most productive channels of the economy. Thus, monetary policy
contributes greatly in pushing the growth rate of the economy by raising both saving-income ratio and
investment-income ratio.

Objectives of Monetary Policy:

The monetary policy in developed economies has to serve the function of stabilization and maintaining proper equilibrium
in the economic system. But in case of underdeveloped countries, the monetary policy has to be more dynamic so as to
meet the requirements of an expanding economy by creating suitable conditions for economic progress. It is now widely
recognized that monetary policy can be a powerful tool of economic transformation .
The objectives of monetary policy varies from country to country and from time to time, a brief description of the same
has been as following:
(i) Neutrality of money
(ii) Stability of exchange rates
(iii) Price stability
(iv) Full Employment
(v) Economic Growth
(vi) Equilibrium in the Balance of Payments.
1. Neutrality of Money:
Economists like Wicksteed, Hayek and Robertson are the chief exponents of neutral money. They hold the
view that monetary authority should aim at neutrality of money in the economy. Any monetary change is
the root cause of all economic fluctuations. According to neutralists, the monetary change causes distortion
and disturbances in the proper operation of the economic system of the country. exponents of neutral
money. They hold the view that monetary authority should aim at neutrality of money in the economy. Any
monetary change is the root cause of all economic fluctuations.

They are of the confirmed view that if somehow neutral monetary policy is followed, there will be no
cyclical fluctuations, no trade cycle, no inflation and no deflation in the economy. Under this system,
money is kept stable by the monetary authority. The main aim of the monetary authority is not to deviate
from the neutrality of money. It means that quantity of money should be perfectly stable. It is not expected
to influence or discourage consumption and production in the economy.

2. Exchange Stability:
Exchange stability was the traditional objective of monetary authority. This was the main objective
under Gold Standard among different countries. When there was disequilibrium in the balance of
payments of the country, it was automatically corrected by movements. It was popularly known,
“Expand Currency and Credit when gold is coming in; contract currency and credit when gold is
going out.” This system will correct the disequilibrium in the balance of payments and exchange
stability will be maintained.

It must be noted that if there is instability in the exchange rates, it would result in outflow or
inflow of gold resulting in unfavorable balance of payments. Therefore, stable exchange rates play
a key role in international trade. Thus, it is clear from this fact that: the main objective of
monetary policy is to maintain stability in the external equilibrium of the country . In other
words, they should try to eliminate those adverse forces which tend to bring instability in exchange
rates.

(i) It leads to violent fluctuations resulting in encouragement to speculative activities in the

market.

(ii) Heavy fluctuations lead to loss of confidence on the part of domestic and foreign capitalists
resulting in adverse impact in capital outflow which may also result in capital formation and
growth.

(iii) Fluctuations in exchange rates bring repercussions in the internal price level.
3. Price Stability:

The objective of price stability has been highlighted during the twenties and thirties of the present
century. In fact, economists like Crustar Cassels and Keynes suggested price stabilization as a main
objective of monetary policy. Price stability is considered the most genuine objective of
monetary policy. Stable prices repose public confidence because cyclical fluctuations are totally
eliminated.

It promotes business activity and ensures equitable distribution of income and wealth. As a
consequence, there is general wave of prosperity and welfare in the community. Price stability also
impedes economic progress as there is no incentive left with the business community to increase
production of qualitative goods.

It discourages exports and encourages imports. But it is admitted that price stability does not
mean ‘price rigidity’ or price stagnation’. A mild increase in the price level provides a tonic for
economic growth. It keeps all virtues of a stable price.

4. Full Employment:

During world depression, the problem of unemployment had increased rapidly. It was regarded as
socially dangerous, economically wasteful and morally deplorable. Thus, full employment assumed
as the main goal of monetary policy. In recent times, it is argued that the achievement of full
employment automatically includes prices and exchange stability.

However, with the publication of Keynes’ General Theory of Employment, Interest and Money in
1936, the objective of full employment gained full support as the chief objective of monetary
policy. Prof. Crowther is of the view that the main objective of monetary policy of a country is
to bring about equilibrium between saving and investment at full employment level.
Similarly, Prof. Halm has also favoured Keynes’ view. Prof. Gardner Ackley regards that the
concept of full employment is ‘slippery’. Full employment, thus, exists when all those who are
ready to work at the existing wage rate get work. Voluntary, frictional and seasonal unemployed
are also called employed.

According to their version, full employment means absence of involuntary unemployment.

Therefore, it implies not only employment of all types of labourers but also includes the
employment of all economic resources. It is not an end in itself rather a pre-condition for
maximum social and economic welfare.

Keynes equation of income, Y = C + I throws light as to how full employment can be secured with
monetary policy. He argues that to increase income, output and employment, it is necessary to
increase consumption expenditure and investment expenditure simultaneously. This indirectly
solves the problem of unemployment in the economy. Since the consumption function is more or
less stable in the short period, the monetary policy should aim at raising investment expenditure.

As monetary policy is the government policy regarding currency and credit, in this way,
government measures of currency and credit can easily overcome the problem of trade fluctuations
in the economy. On the other side, when the economy is facing the problem of depression and
unemployment, private investment can be stimulated by adopting ‘cheap money policy’ by the
monetary authority.

5. Economic Growth:

In recent years, economic growth is the basic issue to be discussed among economists and
statesmen throughout the world. Prof. Meier defined “Economic growth as the process whereby
the real per capita income of a country increases over a long period of time.” It implies an increase
in the total physical or real output, production of goods for the satisfaction of human wants.

In other words, it means utilization of all the productive natural, human and capital resources in
such a manner as to ensure a sustained increase in national and per capita income over time.

Therefore, monetary policy promotes sustained and continuous economic growth by maintaining
equilibrium between the total demand for money and total production capacity and further
creating favourable conditions for saving and investment. For bringing equality between demand
and supply, flexible monetary policy is the best course.

In other words, monetary authority should follow an easy or tight monetary policy to suit the
requirements of growth. Again, monetary policy in a growing economy, has to satisfy the growing
demand for money. Thus, it is the responsibility of the monetary authority to circulate the proper
quantity and quality of money.

6. Equilibrium in the Balance of Payments:

Equilibrium in the balance of payments is another objective of monetary policy which emerged
significant in the post war years. This is simply due to the problem of international liquidity on
account of the growth of world trade at a more faster speed than the world liquidity.

It was felt that increasing of deficit in the balance of payments reduces, the ability of an economy
to achieve other objectives. As a result, many less developed countries have to curtail their imports
which adversely effects development activities. Therefore, monetary authority makes efforts that
equilibrium should be maintained in the balance of payments.

Advantages and Disadvantages of Monetary Policy:

Advantages in using monetary policy as a tool for correcting the problems of inflation and un -
employment. A primary advantage is the speed with which changes can be implemented..
A second advantage of using monetary policy is its flexibility with regard to the size of the
change to be implemented. Reserves can be increased or decreased in small or large incre ments.

One of the major disadvantages of monetary policy is the loan-making link through which it
is carried out. That is, the R.B.I. can increase reserves to stimulate economic activity as much as it
wants, but the reserves themselves do not alter the money supply.

For the money supply to increase someone must be willing to borrow and a bank must be willing to
lend. Because the R.B.I. cannot force the loan-making process, it has only indirect control over
increasing the money supply. This loan-making link may reduce the effectiveness of monetary
policy in fighting unemployment during a deep and serious recession. If economic conditions are
severe, no expansion of reserves or lowering of the interest rate may be enough to induce
borrowers to take loans.

A second problem with monetary policy occurs during inflation. As the Reserve Bank tightens
the money supply and forces the interest rate higher, it raises the price for borrowed money.
Businesses that borrow at this high rate may, in turn, raise prices on their products to compensate.
Thus, fighting inflation with monetary policy could worsen it.

Limitations of Monetary Policy:

Through its credit control instruments like CRR, OMOs, bank rate, etc., a central bank-aims to control the
broad monetary base and broad liquidity. But sometimes serious problems arise. This makes monetary
policy an ineffective weapon.

These institutions now provide huge lendable resources in the economy. Because of restrictive monetary
policy applied by the central bank, some sort of disintermediation—switching off business away from the
banks which are subject to control—takes place.

Banks often induce customers to take loan in a foreign currency from one of their overseas branches and
then convert the currency into rupees. In the absence of foreign exchange control, this practice is followed
by banks. Anyway, lending continues in the midst of restrictive monetary policy. These problems,
therefore, seriously restrict the efficacy of monetary policy.

Monetary policy is less effective in controlling cost-push variety of inflation. Today, an administered price-
wage system conduces cost-push inflation. Price hike of, say, petroleum products, and salary revision of
government employees are considered to be the most important sources of inflation in India.

Such administered wage-price system is not subject to central bank’s credit control instruments.
Again, black money is another source of inflation. Monetary policy, in fact, cannot combat black
money. However, for this the central bank must not be blamed.

In government-run industries, government is the supplier of lendable resources. These industries

may not be handicapped by the shortage of money. Thus, contractionary monetary policy pursued
by the central bank loses much of its effectiveness when government provides funds for its
industries.

In view of this, it is said that a government committed to a sustained reduction in the growth of
money supply will find this very difficult unless it restricts the size of the public sector deficit.

But it is difficult to control the volume of deficit since the government is rather hesitant in raising
tax rates and in cutting government expenditure. Consequently, demand for money and supply of
money increase—thereby frustrating the effectiveness of monetary policy.

One of the important problems of monetary policy is that it does not produce immediate effects,
but operates only after some time lag. In policy making, one observes decision lags and
implementation lags. Decision lags arise because of bureaucracy. Further, policy makers are rather
cautious in changing policy.
Implementation lags arise because policy changes take time to impact on economic behaviour.
Lipsey and Chrystal argue that the long and unpredictably variable implementation lag “makes
monetary fine-tuning difficult and possibly destabilizing. This is because the impact of the
policy is felt much later than the time the policy decision is made, and circumstances may
have changed in the meantime.”

Fiscal Policy
The Philippines have created a contractionary fiscal policy. They have done so by increasing the social tax
rates "from 10.4% to 11%" (The Philippines). This tax increase was put into place so that the government
would be able to generate more income.
Results of Policy
Inflation will fall since there will be less money in circulation.
Unemployment will rise since employers will be forced to make cuts.
GDP will fall because the economy will slow from the effect of the policy.
Graph

Monetary Policy
The Philippines will have contractionary monetary policy put into place within the near future. The
Philippine Central Bank has made plans to raise benchmark interest rates. The lending rates have been at
record lows since 2012 and BSP Governor, Amando, states that a raise in interest rates would be "ideal"
(Montecillo).
Results of Policy
Inflation will go decrease due to the fact that there will be less money spent.
Unemployment will rise since employer will be forced to make cuts.
GDP will fall since higher interest rates discourages lending.
 Graph

Fiscal policy are "measures employed by governments to stabilize the economy, specifically by manipulating the
levels and allocations of taxes and government expenditures". [1] In the Philippines, this is characterized by continuous
and increasing levels of debt and budget deficits, though there were improvements in the last few years of the first
decade of the 21st century.[2]
The Philippine government's main source of revenue are taxes, with some non-tax revenue also being collected. To
finance fiscal deficit and debt, the Philippines relies on both domestic and external sources.
Fiscal policy during the Marcos Sr., administration was primarily focused on indirect tax collection and on government
spending on economic services and infrastructure development. The first Aquino administration inherited a large fiscal
deficit from the previous administration, but managed to reduce fiscal imbalance and improve tax collection through
the introduction of the 1986 Tax Reform Program and the value added tax. The Ramos administration experienced
budget surpluses due to substantial gains from the massive sale of government assets and strong foreign investment
iyears and administrations. The Estrada administration faced a large fiscal deficit due to the decrease in tax effort and
the repayment of the Ramos administration's debt to contractors and suppliers. During the Arroyo administration, the
Expanded Value Added Tax Law was enacted, national debt-to-GDP ratio peaked, and underspending on public
infrastructure and other capital expenditures was observed.

Revenues and funding[edit]

A comparative graph of Revenue and Tax Effort from 2001 to 2010 [3]A comparative graph of Tax and
Non-Tax Revenue contribution from 2001 to 2010[4]
The Philippine government generates revenues mainly through personal and income tax collection, but
a small portion of non-tax revenue is also collected through fees and licenses, privatization proceeds
and income from other government operations and state-owned enterprises.
Tax revenue
Tax collections comprise the biggest percentage of revenue collected. Its biggest contributor is
the Bureau of Internal Revenue (BIR), followed by the Bureau of Customs (BOC). Tax effort as a
percentage of GDP has averaged at roughly 13% for the years 2001–2010. [5]
Income taxes
Income tax is a tax on a person's income, wages, profits arising from property, practice of profession,
conduct of trade or business or any stipulated in the National Internal Revenue Code of 1997 (NIRC),
less any deductions granted.[6] Income tax in the Philippines is a progressive tax, as people with higher
incomes pay more than people with lower incomes. Personal income tax rates vary as such: [7]
E-VAT
The Expanded Value Added Tax (E-VAT), is a form of sales tax that is imposed on the sale of goods and services
and on the import of goods into the Philippines. It is a consumption tax (those who consume more are taxed more)
and an indirect tax, which can be passed on to the buyer. The current E-VAT rate is 12% of transactions. Some items
which are subject to E-VAT include petroleum, natural gases, indigenous fuels, coals, medical services, legal
services, electricity, non-basic commodities, clothing, non-food agricultural products, domestic travel by air and sea. [10]
The E-VAT has exemptions which include basic commodities and socially sensitive products. Exemptible from the E-
VAT are:[11]

1. Agricultural and marine products in their original state (e.g. vegetables, meat, fish, fruits, eggs and rice),
including those which have undergone preservation processes (e.g. freezing, drying, salting, broiling,
roasting, smoking or stripping);
2. Educational services rendered by both public and private educational institutions;
3. Books, newspapers and magazines;
4. Lease of residential houses not exceeding ₱10,000 monthly;
5. Sale of low-cost house and lot not exceeding ₱2.5 million
6. Sales of persons and establishments earning not more than ₱1.5 million annually.
Tariffs and duties
Second to the BIR in terms of revenue collection, the Bureau of Customs (BOC) imposes tariffs and duties on all
items imported into the Philippines. According to Executive Order 206, returning residents, Overseas Filipino Workers
(OFW's) and former Filipino citizens are exempted from paying duties and tariffs. [12]

Non-tax revenue
Non-tax revenue makes up a small percentage of total government revenue (roughly less than 20%), and consists of
collections of fees and licenses, privatization proceeds and income from other state enterprises. [13]
The Bureau of the Treasury
The Bureau of the Treasury (BTr) manages the finances of the government, by attempting to maximize revenue
collected and minimize spending. The bulk of non-tax revenues comes from the BTr's income. Under Executive Order
No.449, the BTr collects revenue by issuing, servicing and redeeming government securities, and by controlling the
Securities Stabilization Fund (which increases the liquidity and stabilizes the value of government securities [14])
through the purchase and sale of government bills and bonds. [15]
Privatization
Privatization in the Philippines occurred in three waves: The first wave in 1986–1987, the second during 1990 and the
third stage, which is presently taking place.[16] The government's privatization program is handled by the inter-agency
Privatization Council and the Privatization and Management Office, a sub-branch of the Department of Finance.[17]
PAGCOR
The Philippine Amusement and Gaming Corporation (PAGCOR) is a government-owned corporation established in
1977 to stop illegal casino operations. PAGCOR is mandated to regulate and license gambling (particularly in
casinos), generate revenues for the Philippine government through its own casinos and promote tourism in the
country.[18]

Spending, debt and financing[edit]

A comparative graph of National Revenues and Expenditures from 2001 to 2010[5]A comparative graph of
Domestic and External Sources of Financing from 2001 to 2010[5]A comparative graph of Total National Debt
from 2001 to 2010[19]
Government spending and fiscal imbalance[edit]
In 2010, the Philippine government spent a total of ₱1.5 trillion and earned a total of ₱1.2 trillion from tax and
non-tax revenues, thus resulting to a total deficit of ₱314.5 trillion.[5]
Despite the national deficit of the Philippines, the Department of Finance reported an average of ₱29.6 billion
in local government unit (LGU) surplus, which is mostly due to an improved LGU financial monitoring system
which the government implemented in the recent years. Efforts of the monitoring system include "debt
monitoring and creditworthiness monitoring system, effective mobilization of second generation funds (SGF) to
promote LGU development, and the implementation of a Land Administration and Management Project (LAMP2)
which received a 'very good' rating from the World Bank (WB) and Australia
External Sources of Financing are:[21]
 1. Program and Project Loans – the government offers project loans to external bodies and uses the proceeds to
fund domestic projects like infrastructure, agriculture, and other government projects. [20]
2. Credit Facility Loans
3. Zero-coupon Treasury Bills
4. Global Bonds
5. Foreign Currencies
Domestic Sources of Financing are[21]

1. Treasury Bonds
2. Facility loans
3. Treasury Bills
4. Bond Exchanges
5. Promissory Notes
6. Term Deposits
In 2010, the total outstanding debt of the Philippines reached ₱4.718 trillion: ₱2.718 trillion from outstanding domestic
sources and ₱2 trillion from foreign sources. According to the Department of Finance, the country has recently
reduced dependency on external sources to minimize the risks caused by changes in the global exchange rates.
Efforts to reduce national debt include increasing tax efforts and decreasing government spending. The Philippine
government has also entered talks with other economic entities, like the ASEAN Finance Ministers Meeting (AFMM),
ASEAN+3 Finance Ministers Meeting (AFMM+3), Asia-Pacific Economic Cooperation (APEC), and ASEAN Single-
Window Technical Working Group (ASW-TWG), in order to strengthen the countries' and the region's debt
management efforts.[20]
COORDINATING FISCAL AND MONETARY POLICY
Issues on Monetary Policy Efficiency
Although monetarism is as alive and well as ever, considerable skepticism and contrary opinions can be found that
surprisingly echoes the vital flaw in human reasoning: expectations. The twin realization that it is impossible to observe
expectations directly, and that reasoning is supposed to be based largely on experience, made monetarists confront the
issues of credibility and sustainability among decision-makers.
Expectations.
The monetarist theoretical scenario has a strong policy message. The existence of an “expectations component” in the
argument means that lags of various kinds exist within the implementation of monetary policy. The central bank in itself
has both the inside and outside lags to contend with. Inside lags exist because of administrative delays and delays in the
recognition of adverse macroeconomic developments in output, employment and prices. While these may be of shorter
actual duration than in the case of fiscal policy, the outside lag – the length of time it takes before the actual changes in
monetary expansion/contraction are felt on the “target” variables of inflation, output, and employment – is very
significant. In the monetarist view, expectations adjustment is a time-consuming process. Comparatively little is known,
however, about the formation of expectations and other factors affecting the length of lags. For that reason, a good deal
of uncertainty accompanies the conduct and effectiveness of monetary policy
For the Monetarists, such efforts are frequently destabilizing (that is, doing the opposite of what they were supposed to
do). Thus, the attempt to apply Keynesian policies, notably in the United States and Britain produced alternating periods
of rising inflation and rising unemployment, and not the finely adjusted trade-off that the Keynesians sought.
No perfect forecast.
Forecasting proved a weak foundation for policy actions. The best forecasts of spending, output, prices, and inflation
proved to be unreliable. Systematic studies of forecasting accuracy show that on average forecasters have been unable to
distinguish between booms and recessions a quarter or a year ahead, so they are as likely to mislead as to benefit
policymakers
Philippine Case: Structures and Arrangements Fiscal policy.
Fiscal balance is important in achieving economic stability, and there are two important issues that must be addressed: (1)
the sustainability of the fiscal balance, and (2) the impact of government spending and debt on the economic growth
(Paderanga, 2001).
For the sustainability of the fiscal balance, the ability of the economy to accumulate savings in order to finance its public
investment is very important. Unfortunately, the slow accumulation of savings by the public sector has been offsetting the
high savings achieved by the private sector. This resulted in negative savings-investment gap for 17 consecutive years.
The second issue relating to fiscal policy for sustainable growth is the impact of government spending and debt on
economic growth. The debt burden keeps the government from providing services to the people and the necessary
infrastructure to help improve the economy. The trend in the government’s budgetary policies is a rising allocation for
general public services and a decreasing budget for economic services. This means that the government is in essence
spending more for less important matters and spending less on areas that are more crucial in achieving sustainable
growth.
Monetary policy.
Despite evidence showing that only M1 is co-integrated with interest rates, output and the exchange rate (Gochoco-
Bautista, 1993), the Central Bank of the Philippines (CBP) used M3 or total liquidity as its intermediate target, specifically
because the ultimate target is the rate of inflation.2 As an intermediate target, the CBP used the base money (BM) as
operating target, and the BM is related to M3 via the money multiplier, i.e. M3 = money multiplier x BM.

National Government Debt Recorded at P12.89 Trillion as of end-July 2022 MANILA, Philippines, 03 September 2022 –
The National Government’s (NG) total outstanding debt reached P12.89 trillion as of end-July 2022. The P96.09 billion or
0.8% increment from the end-June 2022 level was due to the net issuances of domestic and external loans as well as
currency adjustments. NG debt has increased by P1.16 trillion or 9.9% since end-December 2021 but the debt-to-GDP
ratio has improved to 62.1% as of end-Q2 2022 from the 63.5% recorded in the previous quarter as the economy
continues to recover from the health crisis. Of the total debt stock, 31.5% was sourced externally while 68.5% were
domestic borrowings.
MANILA, Philippines — The country’s outstanding debt soared to P13.42 trillion in end-2022, with its
share to the overall economy easing to 60.9 percent following a strong performance last year.
However, 2023 is expected to be a true test of growth momentum for the Philippines amid global
headwinds.

Latest data from the Bureau of the Treasury showed that the national debt stood at P13.42 trillion at
end-2022, 14.4 percent higher than the end-2021 level of P11.73 trillion.

TOOLS OF MONETARY POLICY

1. Open market operations refer to central bank’s activity of buying or selling of government
securities in the open market. This tool is used to effect changes in interest rates.
2. Discount policy – the Central Bank lends money to depository institutions. The interest rate
charged to the borrowers is called the discount rate. The discount policy involves changes in the
discount rate. Any increase in discount loans adds to the monetary base and results to an expanded
money supply. Any decrease in discount loans reduces the monetary base which results to a reduced
money supply.
3. Reserve requirements – refer to the regulation making it obligatory for depository institutions
(those accepting deposits) to keep a certain fraction of their deposits in accounts with the central
bank (BSP) helps the central bank exercise more precise control over the money supply.

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