The document discusses the Bangko Sentral ng Pilipinas' (BSP) conduct of monetary policy. It outlines the BSP's objectives of maintaining price stability and inflation targeting framework. The BSP uses various monetary policy tools like open market operations, reserve requirements, and rediscounting to influence money supply and inflation. Recent inflation trends have remained within target. Large capital inflows from advanced economies pose challenges to managing inflation risks.

1. The BSP’s Conduct of
Monetary Policy
ZENO RONALD R. ABENOJA
Director
Economic and Financial Learning Center
University of the Philippines Manila
13 July 2011

2. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

3. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

4. The 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.

5. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

6. What is price stability?
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

7. What is price stability?
Price stability
• On average, prices
neither increase
nor decrease
markedly
• There is low and
stable inflation

8. 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

9. 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

10. What causes inflation?
Prices increase when…
• Supply < Demand
• Demand > Supply
Prices decrease when…
• Supply > Demand
• Demand < Supply
Changes in price level result from interaction of
supply and demand.

11. What causes inflation?
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

12. What causes inflation?
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

13. Why is price stability important?
Impact of high inflation on the economy
Distorts
economic Inefficient
decisions: allocation
High • consumption of
• saving resources
and
• investment
volatile • production Slower
inflation economic
Lower confidence in financial growth
instruments as a form of savings
Negative
Loss of
effects on
purchasing
income
power
distribution

14. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

15. What is Monetary Policy?
Level of
Money and Credit
Monetary Policy
Price of
Money and Credit
Actions by a central
bank to manage the
to attain
availability and cost
of money and credit
to attain stable prices
PRICE STABILITY

16. What is Monetary Policy?
Level of
Monetary Policy Money and Credit
Actions by a central
bank to manage the
availability and cost Refers to the
of money and credit level of money or
to attain stable prices credit supply
which a central
bank can directly
control

17. What is Monetary Policy?
Level of
Money and Credit
Monetary Policy
Price of
Actions by a central Money and Credit
bank to manage the
availability and cost Refers to the
of money and credit “price” of savings/
to attain stable prices investment which
influences how
much and where
money goes

18. What are the tools of Monetary Policy?
Level of Quantity
instruments
Money and Credit
Monetary
Policy
Price of Price
Money and Credit instruments
to attain
PRICE STABILITY

19. What are the tools of Monetary Policy?
Monetary Policy instruments
• control directly the availability
Quantity or level of loanable funds
instruments (e.g., reserve requirements,
rediscounting)
Price • influence the rate of return on
instruments financial instruments
(i.e., RRP and RP rates)

20. What are the tools of Monetary Policy?
Monetary Policy instruments
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) Market/
Reduce RRP rates or BSP will
To liquidity Purchase of GS release
money into
the system
Market/
Raise RRP rates or BSP will
To liquidity Sale of GS siphon off
money from 20
the system

21. What are the tools of Monetary Policy?
2. Reserve Requirement – amount of money/liquid
assets that banks are required to keep in their
vaults or deposit with the BSP
Banks have
more money
To liquidity Lower RR for lending
& investments
Banks have
less money
To liquidity Raise RR for lending
& investments

22. What are the tools of Monetary Policy?
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

23. What are the tools of monetary policy?
Rediscounting facility
Increase
rediscounting Banks tend
budget/ to reduce
Banks are
reduce excess
encouraged
To liquidity policy rate reserves;
to refinance
(accordingly, cheaper to
loans with BSP
rediscounting refinance
rate is also loans
reduced)

24. What are the tools of monetary policy?
Rediscounting facility
Reduce Banks tend
rediscounting to raise
budget/ excess
Banks are
increase reserves;
To liquidity discouraged
policy rate more costly
to refinance
(accordingly, to
loans with BSP
rediscounting refinance
rate is also loans
increased)

25. 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)

26. How does Monetary Policy affect prices?
Total Aggregate Demand
Consumption
Quantity
instruments Investment
Affect
Government
Spending
Inflation
Price
instruments Exports
Imports
Monetary Policy manages inflation by influencing aggregate
demand and hence, output growth in the economy.

27. How does Monetary Policy affect prices?
Transmission channels – how monetary policy
affects price and real variables
Supply
Interest Domestic
Rate demand
Domestic
Total inflationary
Credit demand pressure
POLICY
INSTRUMENTS
INFLATION
Expectations
Net
external
Asset prices demand
Import
Exchange prices
rate
Stage 2 Stage 3
Stage 1
15-21 months

28. What is the BSP’s Monetary Policy framework?
Inflation targeting
• 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

29. Why did the BSP adopt IT?
Inflation targeting
• 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

30. How does inflation targeting work?
Inflation targeting: essential elements
• 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

31. How does inflation targeting work?
Inflation targeting: framework
Government sets
inflation target 2 years in advance
(in consultation with BSP)
YES BSP
• Publishes highlights of MB
meetings on monetary policy
2011: 4.0% + 1 ppt discussions
2012: 4.0% + 1 ppt • Publishes Inflation Report
• Releases press statement
FORWARD-
LOOKING Is inflation PROMOTES
forecast in TRANSPARENCY
BSP announces
inflation target (yearly) line with
target?
INCREASES
ACCOUNTABILITY
BSP
• Assesses economic conditions BSP
• Forecasts inflation
• Adjusts policy rates
• Conducts monetary policy
• Issues Open letter to the
COMPREHENSIVE NO President (yearly)

32. How does inflation targeting work?
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.

33. How does inflation targeting work?
BSP’s explanation clauses
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

34. How does inflation targeting work?
Recent developments in BSP’s IT
framework
• 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
Inflation target for 2011: 4.0 + 1.0%
Inflation target for 2012-2014: 4.0 + 1.0%

35. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

36. How has inflation behaved over the years?
Headline inflation
Year-on-
Year-on-year change in percent (2000=100)
25
Oil price hike, peso
2010 ave. = 3.8%
depreciation, natural
calamities (e.g. 2011 YTD ave. = 4.3%
20 earthquakes) Inflation
Targeting
Oil price hike and
rise in prices of agri
15 Power Asian financial commodities
crisis crisis, El Niño Oil
Peso price
Rice crisis depreciation, oil hike
10 price hike RVAT
June 2011
4.6%
5
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 11-Jan

37. How has inflation performed vis-à-vis targets?
vis-
Actual Inflation Inflation Target
Year
(in percent) (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-
based
1 Annual target

38. What is the outlook for inflation?
inflation?
Latest inflation forecasts indicate a manageable
inflation environment over the policy horizon.
* Source: BSP Inflation Report Q1 2011

39. What is the outlook for inflation?
Although inflation pressures have moderated
slightly, the inflation target remains at risk.
Upside risks Downside risks
• Higher global food and oil • Sustained appreciation of
prices the peso
• Potential adjustments in • Weaker global recovery
domestic rice prices and
electricity charges
• Potential impact of
weather disturbances on
agricultural production

40. OUTLINE
A. Introduction
B. Inflation and Price Stability
C. Monetary Policy and Inflation Targeting
D. Inflation: Recent Trends and Outlook
Inflation:
E. Contemporary issues in Monetary Policy

41. Multispeed global recovery
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
Source: IMF World Economic Outlook Update, April 2011

42. Multispeed global recovery
• Uncertainty of external demand poses risks to the
economic 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
42

43. Large capital inflows
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
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”

44. Large capital inflows
Credit take-up has been moderate, with loan growth at pace
with the expansion in economic activity
If current conditions of Liquidity and Bank Lending
Jan 2002 – April 2011; in Php billion
strong external liquidity
continue, these could 5,000 3,000
Domestic Liquidity - lhs
add to market volatility 4,500
2,500
4,000
Bank Lending (Net of RRPs) - rhs
Managing these flows 3,500
2,000
will test the 3,000
2,500 1,500
effectiveness of central 2,000
bank policies 1,500
1,000
1,000
There is also a risk that 500
500
flow of capital would 0 0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
reverse quickly, leading
to costly sudden stops

45. Large capital inflows
Policy toolkit
1. Improved monitoring of capital inflows
2. Greater exchange rate flexibility
3. Reserve accumulation and associated liquidity
management operations
4. Financial sector reforms to deepen financial markets
5. Macroprudential measures to strengthen banking
system health
6. Reform of the FX regulatory framework to encourage
outflows
7. Prepayment of external debt
8. Careful communication to markets about central bank
views/responses
9. Calibrations in monetary policy, when necessary

46. Asset price bubbles
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 macroprudential
instruments to temper asset price
escalations

47. Asset price bubbles
Limited evidence of stretched asset market valuations
Average Land Values, Makati CBD and Ortigas Office and Residential Rental Values
Real Prices, based on rebased CPI Real Prices, based on rebased CPI
(in pesos per square meter) (in pesos per square meter per month)
120,000 700
Makati Ortigas Residential Rental Values Office Rental Values
600
100,000
500
80,000 Q1 2011:
Q1 2011: P351/sq.m
P83,921/sq.m 400
60,000
300
40,000
200
Q1 2011: Q1 2011:
20,000 P38,782/sq.m P239/sq.m
100
0 0
1Q '01
1Q '02
1Q '03
1Q '04
1Q '05
1Q '06
1Q '07
1Q '08
1 Q '09
1 Q '10
1 Q '11
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
2Q
3Q
4Q
1Q '01
1Q '02
1Q '03
1Q '04
1Q '05
1Q '06
1Q '07
1Q '08
1 Q '09
1 Q '10
1 Q '11
PRICE-EARNINGS (P/E) RATIO EFFECTIVE EXCHANGE RATE INDICES OF THE PESO
230
31
Narrow = 171.99 (May 201 1)
29 210
27
190
25
23 170
Broad = 136.23 (May 2011 )
May 2011 = 15.32
21 150
19
130
17
15 110
13 Major Trading Partners = 85.58 (May 2011)
90
11
9 70
7 50
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
47

48. Commodity price increase
Global Food Price Index and Dubai Crude Oil Prices
In Asia, recent bout of 2007 -May 2011
inflation being stoked by Dubai Crude Prices (US$/barrel) FAO Food Price Index (FPI)
140 250
higher costs of food and oil FPI
Jun 2008
FPI
Apr 2011
235
Escalating prices are 120 224.13
FPI
May 2011 200
complicating trade-off 100
232
between keeping a lid on 80
150
prices and sustaining
60
growth 100
Why should we be 40
50
concerned? 20
-Erodes purchasing power 0 0
Jul
Jul
Jul
Jul
Oct
Oct
Oct
Oct
Mar
Apr
Mar
Apr
Mar
Apr
Mar
Apr
Mar
Apr
May
Nov
Dec
May
Nov
Dec
May
Nov
Dec
May
Nov
Dec
May
Jan 2007
Feb
Jun
Aug
Jan 2008
Feb
Jun
Aug
Jan 2009
Feb
Jun
Aug
Jan 2010
Feb
Jun
Aug
Sep
Jan 2011
Feb
Sept
Sept
Sept
-Could force policy
tightening
48

49. • Share of food to Commodity price increase
the consumption
basket is higher Country Food Weight
than those in Myanmar 68.3
Nepal 53.2
some neighboring
Philippines 46.6
countries
Sri Lanka 45.5
Country Energy Cambodia 42.7
Weight Mongolia 41.1
(in Papua New Guinea 40.9
percent) Indonesia 36.0
Singapore 21.0 Fiji 35.4
Indonesia 15.0 Thailand 33.0
Thailand 15.0 Malaysia 30.0
China 26.9
Malaysia 15.0
Taiwan 26.0
China 15.0
Singapore 22.1
Korea, Rep 15.0
Brunei Darussalam 17.1
India 14.0
India* 14.3
Philippines 10.0
Korea, Rep 14.0
Taiwan 7.0
*WPI
Source: Nomura Source: CEIC, official statistic website, and Bloomberg
49

50. Commodity price increase
Compared with neighboring countries, recent Philippine
food inflation is one of the lowest
35.0 35.0
Year on year inflation of selected countries Year on year food inflation of selected countries
January 2008 – May 2011 January 2008 – May 2011
30.0 30.0 Indonesia
Indonesia
25.0 Malaysia Malaysia
25.0
Thailand
Thailand
20.0 Philippines
20.0 Vietnam
Vietnam
15.0
Philippines
15.0
10.0
5.0 10.0
0.0 5.0
Jan-08
Jul-08
Oct-08
Jan-09
Jul-09
Oct-09
Jan-10
Jul-10
Oct-10
Jan-11
Apr-08
Apr-09
Apr-10
Apr-11
-5.0
0.0
Jan-08
Apr-08
Jan-09
Apr-09
Jan-10
Apr-10
Jan-11
Apr-11
Jul-08
Oct-08
Jul-09
Oct-09
Jul-10
Oct-10
-10.0
50

51. Commodity price increase
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:
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
Source: FAO Crop Prospects and Food Situation December 2010

52. Commodity price increase
• 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
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

53. Commodity price increase
Stronger private demand & liquidity growth in some Asian countries compared to
relatively moderate growth in PHL
PCE Growth (YoY, %)
Q1 2010 Q2 2010 Q3 2010
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Indonesia Thailand Malaysia South Korea India Philippines
Source: Bloomberg
Growth in Liquidity (YoY, %)
Q1 2010 Q2 2010 Q3 2010 Q4 2010
25
20
15
10
5
0
I ndonesia Thailand Malaysia South Korea India Philippines China
S ource : Bloomberg
Data for Indonesia, Thailand and China refer to M2 g rowth rates

54. Commodity Price Increase: Persistent?
Upside pressures on
IMF Projections for Consumer Prices
commodity prices
expected to persist in Advanced Emerging and
Economies Developing
2011 and 2012 due to : Economies
strong global demand
supply disruptions and 2009 0.1 5.2
sluggish supply 2010 1.6 6.2
response
2011 2.2 6.9
Inflation pressures more
2012 1.7 5.3
pronounced in emerging
and developing countries Source: IMF WEO Update, April 2011
54

55. Financial stability
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 macroprudential
regulation

56. The BSP’s Conduct of
Monetary Policy
ZENO RONALD R. ABENOJA
Director
Economic and Financial Learning Center
University of the Philippines Manila
13 July 2011