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The BSPs Conduct ofThe BSPs Conduct of

Monetary PolicyMonetary PolicyZENO RONALD R. ABENOJA

DirectorEconomic and Financial Learning Center

University of the Philippines Manila13 July 2011


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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


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OUTLINE







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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 abalanced and sustainable

growth of the economy.

-Sec. 3, RA 7653(New Central Bank Act)

The BSP formulates and implements monetarypolicy consistent with its price stability objective.


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OUTLINE







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Price stability

An environment in which inflation issufficiently low that it is no longer aconsideration 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?


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What is price stability?What is price stability?

Price stability

On average, pricesneither increasenor decrease

markedly There is low and

stable inflation


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What is inflation?What is inflation?

Inflation

sustained increase in theaverage prices of goods andservices typically purchased by

consumers measured as the annual

percentage change in the

Consumer Price Index


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How are prices measured?How are prices measured?

CPI

represents the average priceof a standard basket ofgoods and services

consumed by a typical

Filipino family fora given period

Positive rate of change in CPI =Inflation Rate


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What causes inflation?What causes inflation?

Prices increase when

Changes in price level result from interaction ofsupply and demand.

Supply < Demand

Demand > SupplyPrices decrease when

Supply > Demand Demand < Supply


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Types of inflation

Cost-push

Due to increase in cost ofproduction and other

supply factors (e.g.,weather disturbances,

increase in world oil prices)

Outside the influence of BSP


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Types of inflation

Demand-pull

Due to excess demandrelative to supply of goods

and services (e.g., increase

money supply)

BSP exerts influence overmoney supply and thus can

control inflation


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High

and

volatile

inflation

Distorts

economicdecisions: consumption saving investment

production

Inefficientallocation

ofresources

Slower

economic

growthLower confidence in financial

instruments as a form of savings

Negativeeffects on

incomedistribution

Loss ofpurchasing

power

Impact of high inflation on the economy

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


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OUTLINE







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PRICE STABILITY

toattain

Actions by a centralbank to manage the

availability and costofmoney and creditto attain stable prices

Price ofMoney and Credit

Level of

Money and Credit

Level of

Money and Credit

What is Monetary Policy?What is Monetary Policy?

Monetary Policy


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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 centralbank can directly

control

Level of

Money and Credit

Level of

Money and CreditMonetary Policy



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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



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Monetary

Policy

Level of

Money and Credit

Price of

Money and Credit

PRICE STABILITY

toatt

ain

Quantity

instruments

Price

instruments

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


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Monetary Policy instruments

Quantity

instruments

control directly the

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

rediscounting)

Price

instruments

influence the rate of return onfinancial instruments(i.e., RRP and RP rates)


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

and selling of government securities from/to the publicas well as repurchase and reverse repurchase

agreements (the RP/RRP rate is the main policy

instrument)

To liquidityReduce 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


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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 moneyfor lending

& investments



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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) ordecrease/increase the rediscounting budget



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Banks are

encouraged

to refinanceloans with BSP

To liquidity

Increaserediscounting

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


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Banks are

discouraged

to refinanceloans with BSP

To liquidity

Reducerediscounting

budget/

increase

policy rate

(accordingly,

rediscounting

rate is also

increased)

Banks tendto raise

excess

reserves;

more costlyto

refinance

loans

Rediscounting facility

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


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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)



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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 aggregatedemand and hence, output growth in the economy.


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CreditCredit

ExpectationsExpectationsNetNet

externalexternal

demanddemand

ExchangeExchange

raterate

ImportImport

pricesprices

Asset pricesAsset prices

SupplySupply

Stage 3Stage 1 Stage 2

15-21 months

TotalTotal

demanddemand

DomesticDomestic

inflationaryinflationary

pressurepressure

DomesticDomesticdemanddemand

INFLATIONINFLATION

InterestInterest

RateRate

POLICYPOLICY

INSTRUMENTSINSTRUMENTS

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

Transmission channels how monetary policyaffects price and real variables


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Involves the central bankpublicly announcing aninflation target which itpromises to achieve over acertain period

Formally adopted by theBSP in January 2002 as itsmonetary policy framework

Inflation targeting

What is the BSPs Monetary Policy framework?What is the BSPs Monetary Policy framework?


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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 helpsbuild credibility

Promotes transparency in monetary policy

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

Inflation targeting


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Set a target inflation rate - explicit inflationtargets for some period ahead

Forecast the future path of inflation - using amodel that uses relevant variables and informationindicators

Compare forecast with the target

Difference determines the extent that monetarypolicy has to be adjusted

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

Inflation targeting: essential elements


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Government setsGovernment sets

inflation target 2 years in advanceinflation target 2 years in advance

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

2011: 4.0%2011: 4.0% ++ 11 pptppt2012: 4.0%2012: 4.0% ++ 11 pptppt

BSP announcesBSP 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 theIssues Open letter to the

President (yearly)President (yearly)

BSPBSP

Publishes highlights of MBPublishes highlights of MB

meetings on monetary policymeetings 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: frameworkInflation targeting: framework



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Data disclosure and policy communication

Quarterly inflation report - serves as a monetarypolicy statement

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

Highlights of the meeting of the Monetary Board onmonetary policy - lag of four weeks

Speeches by the Governor and other senior BSPofficials - public presentations and informationcampaign.

Open letter addressed to the President of thePhilippines.



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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 directlyaffect prices (e.g., new taxes and subsidies) Natural disasters and calamities affecting major

sectors of the economy


BSPs explanation clauses


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Establishment ofpoint target Prior to 2008, inflation targets were given by a range(ex: Inflation target 2007: 4-5%)

Establishment ofmedium-term inflation target Beginning 2010, BSP announces a medium-term inflationtarget to help anchor inflation expectations

Recent developments in BSPs ITframework


Inflation target for 2011: 4.0 + 1.0%Inflation target for 2012-2014: 4.0 + 1.0%


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OUTLINE







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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, naturalcalamities (e.g.

earthquakes)

Rice crisis

Asian financial

crisis, El Nio Oil

pricehike

Power

crisis

Peso

depreciation, oilprice 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%


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YearActual Inflation

(in percent)Inflation Target(in percent)1

2002 2.9 4.5 5.5

2003 3.0 4.5 5.52004 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-

based1Annual target

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

h i h l k f i fl ih i h l k f i fl i ??


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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


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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 oilprices

Potential adjustments indomestic rice prices andelectricity charges

Potential impact ofweather disturbances onagricultural production

Downside risks

Sustained appreciation ofthe peso

Weaker global recovery


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OUTLINE






M l i d l b lM l i d l b l


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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

M lti d l b lM lti d l b l


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Uncertainty of external demand poses risks to theUncertainty of external demand poses risks to theeconomic outlookeconomic outlook

Slow recovery scenario for global growth in the USand 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


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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


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Credit take-up has been moderate, with loan growth at pacewith the expansion in economic activity

If current conditions of

strong external liquiditycontinue, these could

add to market volatility

Managing these flows

will test theeffectiveness of central

bank policies

There is also a risk that

flow of capital wouldreverse 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

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Liquidity and Bank Lending

Jan 2002 April 2011; in Php billion

Domestic Liquidity - lhs

Bank Lending (Net of RRPs) - rhs

i l i fli l i fl


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Policy toolkitPolicy toolkit1.1. Improved monitoring of capital inflowsImproved monitoring of capital inflows

2.2. Greater exchange rate flexibilityGreater exchange rate flexibility

3.3. Reserve accumulation and associated liquidityReserve accumulation and associated liquiditymanagement operationsmanagement operations

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

5.5. MacroprudentialMacroprudential measures to strengthen bankingmeasures to strengthen banking

system healthsystem health6.6. Reform of the FX regulatory framework to encourageReform 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 bankCareful communication to markets about central bankviews/responsesviews/responses

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


Asset price bubblesAsset price bubbles


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

The BSP does not actively respond toasset price bubbles

But continues to be highly attentive and

alert to credit growth, asset pricemovements and imbalances

BSP uses variety of macroprudential

instruments to temper asset priceescalations




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47


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

1Q'

09

2Q

3Q

4Q

1Q'

10

2Q

3Q

4Q

1Q'

11

Average Land Values, Makati CBD and Ortigas

Real Prices, based on r ebased 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

1Q'09

2Q

3Q

4Q

1Q'10

2Q

3Q

4Q

1Q'11

Office and Residential Rental Values

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

Residen tial Ren tal Val ues Offi ce Rental Val ues

Q1 2011:P351/sq.m

Q1 2011:

P239/sq.m

7

9

11

13

15

17

19

2123

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 2 002 20 03 2004 2005 2006 2007 2 008 20 09 201 0 2011

Major Trading Partners = 85.58 (May 2011)

Broad = 136 .23 (May 2011 )

EFFECTIVE EXCHANGE RATE INDICES OF THE PESO

Narrow = 171. 99 (May 201 1)

Commodity price increaseCommodity price increase


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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 sustaininggrowth

Why should we be

concerned?

-Erodes purchasing power-Could force policy

tightening

48


0

50

100

150

200

250

0

20

40

60

80

100

120

140

Jan2007

Feb

Mar

Apr

May

JunJul

Aug

Sept

Oct

Nov

Dec

Jan2008

Feb

Mar

Apr

May

JunJul

Aug

Sept

Oct

Nov

Dec

Jan2009

Feb

Mar

Apr

May

JunJul

Aug

Sept

Oct

Nov

Dec

Jan2010

Feb

Mar

Apr

May

JunJul

Aug

Sep

Oct

Nov

Dec

Jan2011

Feb

Mar

Apr

May

Dubai Crude Prices (US$/barrel) FAO Food Pr ice Index (FP I)

FPIMay 2011

232

Global Food Price Index and Dubai Crude Oil Prices

2007 -May 2011

FPIJun2008

224.13

FPIApr 2011

235

Share of food to Commodity price increaseCommodity price increase


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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 21.0Indonesia 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 higherthan those in

some neighboring

countries




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50

Compared with neighboring countries, recent Philippinefood 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

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Indonesia

Malaysia

Thailand

Philippines

Vietnam

Year on year inflation of selected countries

January 2008 May 2011

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Indonesia

Malaysia

Thailand

Vietnam

Philippines

Year on year food inflation of selected countries

January 2008 May 2011



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Some reasons why food inflation is lower in the Philippines

Favorable domestic supply conditionsTimely 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


C dit i iC dit i i


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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



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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

y py p

Stronger private demand & liquidity growth in some Asian countries compared torelatively moderate growth in PHL

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


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IMF Projections for Consumer Prices

Advanced

Economies

Emerging and

DevelopingEconomies

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 oncommodity pricesexpected to persist in

2011 and 2012 due to : strong global demand

supply disruptions andsluggish supply

response Inflation pressures more

pronounced in emerging

and developing countries

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Financial stabilityFinancial stability


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Financial stability dimension of pricestability

Price stability: necessary but notsufficient to achieve financial stability

Emergence of imbalances even whenmonetary policy settings appearappropriate

Best approach is to involve a portfolio of

instruments with macroprudentialregulation

Financial stabilityFinancial stability


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The BSPs Conduct ofThe BSPs Conduct ofMonetary PolicyMonetary Policy

ZENO RONALD R. ABENOJADirector

Economic and Financial Learning Center

University of the Philippines Manila13 July 2011

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