After a great deal of debate it is now generally agreed that the principal responsibility of a central bank is the maintenance of price stability. This responsibility is discharged through control of the supply of money in the economy. Too high a money supply leads, other things being equal, to a situation of too much money chasing too few goods, and too low a money supply level, other things being equal, creates the opposite situation. Either situation is bad for price stability.
The national monetary authority, the Bangko Sentral ng Pilipinas (BSP), has a number of weapons available to it in the performance of its principal statutory responsibility. Its armory is well-stocked and capable of dealing with all but the most disastrous economic situations.
The weapons of the BSP differ in character, purpose and effect. Some are of the broad, across-the-board kind. Other weapons are more focused and are target-specific. But they have something in common: they are all intended to affect the capacity of financial institutions to increase or decrease their lending and investing activities. Knowledgeable observers have portrayed the difference between the across-the-board weapons and the target-specific weapons of the BSP in terms of the difference between a sword and a scalpel. A sword cuts down everything in its path, whereas a scalpel targets only matter that needs excision.
Two weeks ago this country got another taste of BSP policymaking of the across-the-board kind when the national monetary authority reduced the regulatory reserve requirement (RRR) of the commercial banks. RRR is the percentage of their total deposit liabilities that commercial banks are required to keep on deposit with the BSP. The RRR reduction—from 20 percent to 19 percent—is expected to free an estimated P90 billion of their deposit liabilities for – the BSP hopes—incremental lending and investing by the commercial banks.
Considering its impact on the availability and cost of loans and investment funds, an increase and decrease in the RRR is either an expansionary or contractionary move on the part of the monetary authority—expansionary in the case of a decrease and contractionary in the case of an increase. As already stated, the BSP expects an additional P90 billion to be injected in the money stream with the 1 Was the reduction a sound move on the part of the Monetary Board? The right way to approach the answer to this question is to discuss the existing monetary and fiscal environments.
With an average annual GDP (gross domestic product) growth rate or around 6.5 percent in recent years, the economy of this country is not in dire need of monetary stimulation. For 2018 the forecast of the most respected international and domestic financial institutions is a GDP growth rate of around 6.7 percent. On the basis of any of the various difficulties of money supply – M1, M2 and M3 – the economy apparently had enough monetary resources to support the 2018 GDP growth expectations.
Moreover, a time of growing inflation is hardly a good time to inject more liquidity into the monetary stream. The BSP decision to reduce the RRR has come close to the heels of the monetary authority’s decision to bring its 2018 inflation forecast closer to the upper end of itsl2-to-4 percent inflation target range. Is the RRR reduction’s injection of additional funds into the money stream conducive to keeping this year’s inflation rate within the 2-to-4 percent target range? Very likely not.
On the fiscal side, looming very hard on the horizon is Build Build Build, the Duterte administration’s “golden age of infrastructure” program. Such has been the monetary impact of the initial phase of Build Build Build that the current account of the 2017 balance of payments (BOP) sustained a whopping deficit. In the absence of an adequate response on the export side of the trade ledger, there are bound to be more whopping deficits in the next few years. The predictable resulting depreciation of the peso is certain to further stoke the fires of inflation.
This brings us to the core issue of the soundness or unsoundness of the decision to reduce the RRR. Was it a good move by the Monetary Board? Under the circumstances discussed above, was the timing right for the move?
With all due respect to the members of the Monetary Board, especially my esteemed friend Dr. Felipe Medalla, my answers to the two questions are both No.
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