Monetary Policy

Objectives

At the end of the lesson, the students should be able to:

1. differentiate expansionary and contractionary monetary policy;
2. explain the effects of expansionary and contractionary monetary policy in the economy;
3. evaluate the impact of the monetary policy being implemented on the ordinary Filipino;
4. formulate policies that will solve economic issues faced by ordinary Filipinos; and

Introduction

In our lesson about inflation, we learned that inflation is neither good or bad. But, we have to manage to mitigate
its negative effect. One way to stabilize the inflation rate is through the use of the monetary policy.

Content

Definition of Monetary Policy

Monetary policy is measures or actions taken by the central bank or monetary authority to control the money
supply to achieve the following goals:
1. reduce unemployment
2. stabilize inflation rate
3. promote economic growth

Monetary Policy Instruments

Do you know how the BSP influence the economy? In this section we will discuss in detail the different
monetary policy instruments used by the BSP.

The primary objective of BSP's monetary policy is to promote a low and stable inflation conducive to a
balanced and sustainable economic growth. To achieve the desired level of money supply, the BSP use
various monetary policy instruments. These include the following:

1. Policy interest rates

Policy rates are used as reference rates in the determination of market rates, which usually move in
the same direction as the policy rates. The key policy rates used by the BSP are overnight borrowing
rate and overnight lending rate. The overnight borrowing rate is the interest paid by the BSP on deposits
placed overnight by banks while the overnight lending rate is the interest that the BSP charges on loans
it extends overnight to banks.

2. Reserve requirement
Reserve requirement refers to the proportion of banks’ deposits and deposit substitute liabilities that
banks are required to hold as reserves. These required reserves are normally in the form of cash stored
physically in a bank vault (vault cash) or deposits made with a central bank.

3. Special deposit account (SDA)

Special Deposit Accounts are fixed-term deposits by banks and trust entities of BSP-supervised
financial institutions with the BSP.

4. Rediscount rate
 The rediscount rate is the interest rate charged by BSP against the rediscounting loan. Rediscounting
is a special refinancing facility of central banks wherein a financial institution borrows money from the
BSP using promissory notes and other loan papers of its borrowers as collateral.

5. Open market operation

Open Market Operation is a monetary tool which involves the BSP publicly buying or selling government
securities from banks and financial institutions in order to increase or decrease the supply of money.
By controlling the money supply, the BSP is able to exert some influence on the prices of goods and
services and achieve its inflation objectives. Government securities are unconditional obligations of the
sovereign state. It is backed by the full taxing power of the sovereignty. Therefore, government
securities are practically free from default. The Philippine Government issues two kinds of government
securities: Treasury Bills and Treasury Bonds. Treasury bills are government securities which mature
in less than a year while treasury bonds are government securities which mature beyond one year.

When the BSP sells the securities, the Demand Deposit Account of the banks and financial institutions
with the BSP is debited which reduces its reserve account causing money supply to contract.
Conversely, when the BSP buys securities, it pays for them by directly crediting Demand Deposit
Account that is being maintained by the banks or financial institution with the BSP.

Aside from these monetary instruments, the BSP can use moral suasion which is the influence which the BSP
exercises to induce or convince banks to conduct operations in a manner that would contribute to the
attainment of monetary goals but not necessarily support the profit-maximizing objectives of the banks.

Monetary Policy Setting

Like the fiscal policy, monetary policy can either be expansionary or contractionary. Expansionary monetary
policy is a monetary policy setting that intends to increase the level of liquidity/money supply in the economy
and which could also result in a relatively higher inflation path for the economy. Expansionary monetary policy
tends to encourage economic activity as more funds are made available for lending by banks. This, in turn,
increases aggregate demand which could eventually fuel inflation pressures in the domestic economy.
Examples of expansionary monetary policy are lowering of policy interest rates and reduction in reserve
requirements.

Contractionary monetary policy is monetary policy setting that intends to decrease the level of liquidity/money
supply in the economy and which could also result in a relatively lower inflation path for the economy.
Contractionary monetary policy tends to limit economic activity as less funds are made available for lending
by banks. This, in turn, lowers aggregate demand which could eventually temper inflation pressures in the
domestic economy. Examples of this are increases in policy interest rates and reserve requirements.

Summing up

 The monetary policies are actions taken by the monetary authorities to influence the economy. The
Bangko Sentral ng PIlipinas is the body that formulates the monetary policy in our country.
 The Bangko Sentral ng Pilipinas uses several instruments to influence the economy. These are key policy
rates, reserve requirements, rediscount rate, open market operation, and special deposit accounts.
 The monetary policy setting that will be implemented depends on the state of the economy. An
contractionary monetary policy is implemented when prices are rising too fast while an expansionary
monetary policy is implemented in order to encourage economic activity during periods of recession.
 When an expansionary monetary policy setting is implemented, the Monetary Board decreases the
interest rates, buys government securities, decreases the reserve requirement, and opens special
deposit accounts.
 When a contractionary monetary policy setting is implemented, the Monetary Board increases the interest
rates, sells government securities, and increases the reserve requirement.
Key Concepts

Contractionary monetary policy

Expansionary monetary policy
Monetary policy
Open market operation
Overnight borrowing rate
Overnight lending rate
Rediscount rate
Reserve requirement
Special deposit account

Enrichment

About the Bangko Sentral ng Pilipinas https://www.youtube.com/watch?v=5yv1QCkCUpY

Monetary Policy of the Philippineshttps://www.youtube.com/watch?v=dTC9yj6aOx4

Activity

Activity 1: Compare and contrast expansionary and contractionary monetary policy by completing the
table below.

Expansionary Contractionary
What happens to the money supply
when the policy is implemented?
Effect on the economic activity
Effect of the policy on inflation rate
What does the BSP do to the
following monetary instrument
when the policy is implemented?
 Overnight borrowing rate
 Overnight lending rate
 Reserve requirement
 Rediscount rate
 Special deposit account
 Open market operation

Activity 2: Read the news article below and then answer the following questions

1. What is the problem that BSP tries to solve?

2. What are the monetary instruments being used by the BSP to address the problem?
3. What policy setting is being implemented by the BSP to address the problem?

Bangko Sentral raises keypolicyrates

By Paolo G. Montecillo |Philippine Daily Inquirer
12:13 am | Friday, August 1st, 2014

Interest rates were raised yesterday for the first time since 2011 as monetary authorities,
confident that the economy was strong enough to take it, sought to curb excess demand that
could push consumer prices further up. The Bangko Sentral ng Pilipinas (BSP) noted that food
prices remained elevated and prospects for the rest of the year remained uncertain given the
lingering damage from recent typhoons and pending petitions for utility rate increases.
 “Latest baseline forecasts indicate that the inflation target could be at risk,” BSP Governor
Amando M. Tetangco Jr. said in a statement.

The BSP’s overnight borrowing and lending rates were increased by a quarter of a percentage
point to 3.75 percent and 5.75 percent, respectively. Both benchmarks stood at record lows
since late 2012. He said the balance of risks to the inflation outlook “continues to be tilted
toward the upside,” citing higher food prices, short-term volatility in international oil prices and
pending petitions in power rates and transport fares. Yesterday’s action followed three
consecutive policy meetings that have seen monetary settings tightened. In April and May,
banks were told to set aside more of their clients’ deposits as reserves. In June, the central
bank ordered an increase in the yields for special deposit accounts (SDAs), which encourage
banks to keep more funds parked idle in BSP vaults.

According to Tetangco, the move to raise rates showed that growth in the amount of money
circulating in the economy, which was the primary concern in the last three meetings, was no
longer an issue. Inflation for this year is expected to average 4.33 percent versus the previous
forecast of 4.4 percent and last year’s 3 percent. The new projection is within but above the
midpoint of the target range of 3 to 5 percent. Next year, inflation is seen at 3.72 percent, higher
than the previous forecast of 3.65 percent. The inflation target for 2015 is 2 to 4 percent. The
BSP also issued a forecast of 2.8 percent for 2016. The target for that year is also 2 to 4
percent.

Source http://business.inquirer.net/175710/bangko-sentral-raises-key-policy-rates#ixzz39ChJUUTR

Activity 3: Web Quest (Collaborative work)

Expected output: A policy brief addressed to the President of the Philippines
Prepared by the Social Studies Group

Rona Christina Almazan

Mernita Bandoy
Dr. Amelia Bobadilla
Dr. Ruby Brion
Gloribel Cordez
Dr. Josefina de Jesus
Nineveth E. Emlano
Dr. Ray Samuel G. Grecalda
Arnold Abad C. Tenorio
Dr. August V. Tuiza