"Will the BSP go through with its governor's announced desire to further ease monetary conditions?"
When asked what he thought was the principal function of a central bank, one of the earliest chairmen of the board of governors of the US’ Federal Reserve Board, Marriner Eccles gave this memorable answer: “The job as central bank is to lean against the prevailing economic winds.” I am reminded of Mr. Eccles’ statement because of the likely confluence of forces that will shape the environment for Philippine monetary policymaking during the year that has begun.
In 2020 the most powerful prevailing economic wind that this country’s monetary authority, the BSP (Bangko Sentral ng Pilipinas) will have to lean against will be expenditure program of the government. By far the largest component of the program is spending on infrastructure—Build, Build, Build—for which the administration of President Rodrigo Duterte has budgeted close to P800 billion. A lot of Build, Build, Build money will be entering the financial stream this year, for Congress approved the extension of the delayed 2019 GAA (General Appropriations Act) to 2020. In addition to authorizing stepped-up infrastructure spending, these two annual budgets provide for increases in the salaries of groups of civil servants.
The resulting incremental incomes will give rise to an increase in the money supply, which in turn will exert upward pressure on producer and consumer prices. These pressures are likely to degenerate into an inflationary situation if not addressed effectively.
It is not only demand-side inflation that the BSP will have to face—and lean against—in 2020. It will, in addition, have to contend with supply-side inflationary pressures arising from the implementation, starting January 1, of the third phase of the petroleum-products excise tax component of the TRAIN (Tax Reform and Inclusiveness) law. The third phase calls for excise tax increases of P1.50 per liter of diesel and bunker fuel and P1.00 per liter of LPG (liquefied petroleum gas), kerosene, gasoline and lubricating oil. Considering that LPG is a major component of the average consumer’s daily budget and that the other petroleum products—bunker fuel, diesel, gasoline and lubricants are key inputs into the power, transportation and manufacturing sectors of the Philippine economy, there is bound to be a re-ignition of the inflationary flame that caused the inflation rate to side, in 2018, to 6.7 percent, its highest level in five years.
The inflationary trend would be strengthened by a decline in the value of the peso resulting from the rising costs of imported consumer goods and production inputs.
Clearly, the “prevailing economic headwinds” that the BSP will have to lean against in 2020 are the inflation-generating programs of the Duterte administration, to wit, Build, Build, Build and TRAIN 2’s third-phase excise tax increases. Normally, the leaning will take the form of policy measures either (1) to decrease the money supply or (2) to prevent an increase in money supply; the BSP has numerous tools in its armory for achieving either or both of these policy objectives. However, there may be a problem here—and the BSP and the fiscal agencies of the Executive Department may not be in tandem—in view of certain declarations that the Governor of the BSP has made in recent weeks.
The Governor’s declarations have all been expansionary in tone. On various occasions, he has intimated to the media that there could be further lowerings of the BSP’s interest rates. And he has virtually committed the Monetary Board to further reductions in the banks’ RRR (required reserve ratio), which stands today at 14 percent of their deposit liabilities. Changes in the central bank’s interest rates—for lending and borrowing—and in the RRR have a profound impact on the level of money supply.
Essentially, a central bank’s leaning against the prevailing economic winds means that it operate in a manner that provides counter-balance to the operations of the fiscal agencies of the Executive Department, i.e., DOF (Department of Finance) and DBM (Department of Budget and Management). The monetary and fiscal sectors of the economy cannot both operate in an expansionary or a contractionary manner: that would be disastrous because inflation—even hyperinflation—would be the result in the first instance and recession would be the outcome of the latter instance. When the fiscal sector is pursuing inflationary programs, such as Build, Build, Build, the monetary sector should not create additional demand with policies that make access to credit easier to obtain.
With the fiscal sector poised to engage in stepped-up infrastructure spending to make up for the publicized performance shortfall, and with consumers able and eager to maintain a high level of spending, there should be no need for stimulative monetary policy-making in 2020. Will the BSP go through with the Governor’s announced desire to further ease monetary conditions? The probability is high. If it does so, it will be going against the grain of the leaning-against-the-prevailing-winds theory of monetary policymaking. On the contrary, it will be giving support to those winds.