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A monetary remedy for a fiscal problem

When government economists and private-sector financial analysts are asked to describe the state of the Philippine economy, they always recite the mantra “The Philippine economy’s macro-economic fundamentals are sound.” The stability of a country’s interest-rate structure is one of its macro-economic fundamentals, and the fact that the key interest rates of the Bangko Sentral ng Pilipinas have been unchanged since September 2014 has been cited in support of the position that the Philippines is a country with sound macro-economic fundamentals.

With the decision taken by the Monetary Board on May 10, this country’s macro-economic fundamentals are no longer as sound as they used to be. During its regular meeting on that day the policymaking body of the BSP raised the monetary authority’s key interest rate—its overnight rate—by 25 basis points, to 3.25 percent. The Monetary Board explained its not-unexpected action: “In deciding to raise the policy interest rate, the Monetary Board noted that the latest (inflation) forecasts had further shifted higher, indicating that inflationary pressures could become more broad-based over the policy horizon.”

From this statement it is clear that the Monetary Board had “inflationary pressures” very much in mind when it approved the increase in the BSP’s key interest rate—the rate that it charges on loans to banks—by 25 basis points. With their borrowings from the BSP now more costly, the institutions that compose the Philippine banking system adjust their loans to producers and consumers correspondingly.

Did the Monetary Board do the right thing when it took its May 10 policy action? Was a BSP rate-increasing exercise the appropriate way to deal with the “inflationary pressures” it cited in explaining its action?

To place things in perspective, the May 10 Monetary Board action came close on the heels of the steady upward movement of consumer prices since Jan. 1, 2018, when the TRAIN (Tax Reform and Inclusion) law went into effect, culminating in the Philippine Statistics Authority announcement that the inflation rate rose to a target-busting 4.5 percent in April. Understandably, the Monetary Board did not want to be seen as being inactive in the face of an apparent sustained inflationary movement, so it lost no time assuming an anti-inflation posture. Of the numerous weapons in its armory, it chose to deploy interest-rate policy.

Interest-rate changes are resorted to by monetary authorities to influence producers’ and consumers’ decisions to borrow and spend money. They seek to discourage lending (by banks) and borrowing (by producers and consumers) when they sense that an economy is at or is nearing overheating point; conversely, they encourage lending and borrowing when they sense that an economy is displaying deflationary tendencies, with unused productive capacities—including labor-building up.

And what were the sources of the “inflationary pressures” that the Monetary Board cited in its May 10 statement? The same statement provided the answers. “(P)rice pressures (have been) emanating from possible adjustments in transport fares, utility rates and wages.” These adjustments have been directly attributable to the increases in petroleum-products excise taxes that TRAIN put into effect on Jan. 1, 2018. Raise fuel prices and you raise the prices of goods and services that use fuel in their production.

The last time I checked, there were no indications of overheating in the economy. On the one hand, there are no shortages of raw materials and semi-processed products; on the other hand, unemployment and underemployment remain at unacceptably high levels. Indeed, the BSP loses no opportunity to reassure the nation that there is no economic overheating.

Thus, what we have here is a case of a fiscal problem being addressed with monetary policy. A checking of my economics notes yielded the rule that fiscal problems should be solved with fiscal policy tools and monetary problems should be solved with monetary weaponry.

The fiscal problem created by TRAIN—upward “adjustments in transport fares, utility rates and wages” —should be solved with adjustments in TRAIN, not interest rate charges.

A fiscal problem being solved with a monetary tool: That ain’t right.

Topics: macro-economic , Philippine economy , Monetary Board , Bangko Sentral ng Pilipinas , Tax Reform and Inclusion law
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