The New Central Bank Act of 1993 created the Bangko Sentral ng Pilipinas and entrusted it with a pivotal task: maintaining price stability in the country.
Price stability refers to managing and controlling inflation within an acceptable range to avoid drastic fluctuations in the price levels of goods and services in the economy.
For consumers, price stability protects their purchasing power and overall standard of living. For businesses, it reduces uncertainty and allows for more accurate planning. By fulfilling this role, the BSP fosters an environment conducive to the efficient operation of financial markets and the sustainable growth of the economy.
From 1993 to 2023, the BSP’s strategy for maintaining price stability has evolved in line with the changing economic landscape, domestically and globally. In its early years, the BSP adopted a monetary targeting framework, under which it would target a certain level of money supply in the economy to manage inflation.
As many countries, including the Philippines, experienced a weakening relationship between inflation and money supply, however, the BSP shifted its framework in 2002. It adopted inflation targeting as its primary approach to monetary policy. Under this framework, the BSP directly targets a range of inflation. It publicly announces the target inflation range and uses its tools to meet the target.
Shift to inflation-targeting
Inflation targeting refers to a monetary policy strategy where the central bank sets a specific inflation rate as its goal and implements monetary policy decisions, such as adjusting interest rates, to achieve and maintain this target. This approach is known for its transparency as the BSP explicitly states its inflation target, making its monetary policy decisions useful for planners and easier to understand for the public.
The transition to inflation targeting represented a significant shift in the BSP’s approach to monetary policy. This framework offered the BSP more flexibility to respond to economic shocks, as it focuses on future rather than past inflation, allowing for preemptive measures. Moreover, the clear communication that characterizes inflation targeting—whereby the BSP regularly informs the public of its target, its outlook for inflation, and its assessment of the balance of risks—has helped anchor inflation expectations and thereby reduce inflation volatility.
Expanded toolkit
The BSP utilizes several tools alongside inflation targeting to ensure price stability. One key tool is the reserve requirement, which dictates the minimum reserves each bank must hold from its depositors’ balances. By adjusting the reserve requirement ratio, the BSP can influence the amount of money circulating in the economy, thereby managing inflation.
In 2009, the BSP began incorporating banking regulations meant to help manage liquidity in the economy into its policy toolkit. Indeed, financial stability and price stability are intertwined. As part of its oversight function, the BSP set the thresholds for key metrics, such as loan-to-value ratio (or the difference between the loan amount and the current market value of a property) and capitalization. Stress testing exercises are also conducted. The objective is to protect the financial system from potential shocks and to prevent unsustainable credit growth.
The BSP also adopted an interest rate corridor system in 2009. Under this system, the BSP keeps a lower and an upper threshold for interest rates, which better guides banks in putting their own interest rates. This system aims to guide short-term market rates toward the BSP’s policy interest rate, further refining its ability to manage inflation expectations effectively.
Re-anchoring inflation expectations
However, 2022 saw an unprecedented challenge. Across the world, supply chain disruptions caused by the lingering effects of the COVID-19 pandemic and the Ukraine-Russia conflict stoked inflation, triggering rate hikes, higher unemployment, and record-high debts. What made 2022 even more challenging was the US Federal Reserve’s sudden pivot to tighter monetary policy. This narrowed the interest rate differential between the United States and the Philippines and weakened the peso.
To re-anchor inflation expectations, the BSP implemented a cumulative increase of 350 basis points (bps) in the policy rate in 2022, followed by a cumulative 75 bps hike from January to June 2023. This brought the combined rate adjustments to 425 bps, that is, increasing its policy rate by 4.25 percent. Compared with its peers in the region, the BSP was among the most aggressive in raising its policy rate. And similar to other countries, the BSP sold some of its reserves as part of its expanded toolkit.
Under the Tinbergen Rule, policymakers need multiple tools to address several objectives. The BSP avoids overreliance on any single tool and, aside from the policy rate, has several weapons in its arsenal to bring inflation to a target-consistent path.
The BSP maintains close relations with other government bodies, adopting a coordinated approach that allows it to factor in various macroeconomic perspectives when making decisions to contain inflation and protecting the purchasing power of Filipinos.
Meanwhile, the national government implemented non-monetary interventions to address the scarcity of essential food commodities and improve agricultural productivity in the country.
The combined effects of the BSP’s rate hikes and the national government’s move to relax import restrictions on scarce food items have begun to take effect. Based on estimates of the BSP in June 2023, headline inflation is seen to settle within the 3.0 to 4.0 percent target by the fourth quarter of 2023.
The BSP’s pursuit of its price stability mandate over the years demonstrates that it is a proactive and adaptive institution. Its transition from money supply targeting to inflation targeting, the adoption of innovative macroprudential measures, and its response to inflationary pressures reflect the BSP’s commitment to price stability amid changing and challenging economic conditions.