Introduction to Monetary Policy
What Is Monetary Policy?
Monetary policy is a set of tools that a nation's central bank has available to promote
sustainable economic growth by controlling the overall supply of money that is available to the
nation's banks, its consumers, and its businesses.
The goal is to keep the economy humming along at a rate that is neither too hot nor too
cold. The central bank may force up interest rates on borrowing in order to discourage spending
or force down interest rates to inspire more borrowing and spending.
The main weapon at its disposal is the nation's money. The central bank sets the rates it
charges to loan money to the nation's banks. When it raises or lowers its rates, all financial
institutions tweak the rates they charge all of their customers, from big businesses borrowing for
major projects to home buyers applying for mortgages.
All of those customers are rate-sensitive. They're more likely to borrow when rates are low
and put off borrowing when rates are high.
Monetary policy is a set of actions that can be undertaken by a nation's central bank to
control the overall money supply and achieve sustainable economic growth.
Monetary policy can be broadly classified as either expansionary or contractionary.
Some of the available tools include revising interest rates up or down, directly lending cash to
banks, and changing bank reserve requirements.
Reserve requirements are the amount of cash that banks must have, in their vaults or at
the closest central bank, in line with deposits made by their customers. Set by the CB's board of
governors, reserve requirements are one of the three main tools of monetary policy—the other
two tools are open market operations and the discount rate.
Understanding Monetary Policy
Monetary policy is the control of the quantity of money available in an economy and the
channels by which new money is supplied.
By managing the money supply, a central bank aims to influence macroeconomic factors
including inflation, the rate of consumption, economic growth, and overall liquidity.
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In addition to modifying the interest rate, a central bank may buy or sell government
bonds, regulate foreign exchange (forex) rates, and revise the amount of cash that the banks are
required to maintain as reserves.
Economists, analysts, and investors eagerly await monetary policy decisions and even the
minutes of meetings in which they are discussed. This is news that has a long-lasting impact on
the overall economy as well as on specific industry sectors and markets.
What Goes Into Policy Decisions
Monetary policy is formulated based on inputs from a variety of sources. The monetary
authority may look at macroeconomic numbers such as gross domestic product (GDP) and
inflation, industry and sector-specific growth rates, and associated figures.
Geopolitical developments are monitored. Oil embargos or the imposition (or lifting) of
trade tariffs are examples of actions that can have a far-reaching impact.
The central bank may also consider concerns raised by groups representing specific
industries and businesses, survey results from private organizations, and inputs from other
government agencies.
The Mandate
Monetary authorities are typically given broad policy mandates to achieve a stable rise in
gross domestic product (GDP), keep unemployment low, and maintain foreign exchange (forex)
and inflation rates in a predictable range.
In addition to monetary policy, fiscal policy is an economic tool. A government may
increase its borrowing and its spending in order to spur economic growth. Both monetary and
fiscal tools were used lavishly in a series of government and CB e programs launched in response
to the COVID-19 pandemic.
The BSP is in charge of monetary policy in the Philippines. BSP has what is commonly
referred to as a dual mandate: to achieve maximum employment while keeping inflation in check.
That means it is the BSP's responsibility to balance economic growth and inflation. In addition, it
aims to keep long-term interest rates relatively low.
Fiscal policy are "measures employed by governments to stabilize the economy,
specifically by manipulating the levels and allocations of taxes and government expenditures.
Fiscal measures are frequently used in tandem with monetary policy to achieve certain goals." In
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the Philippines, this is characterized by continuous and increasing levels of debt and budget
deficits, though there have been improvements in the last few years.
The Philippine government's main source of revenue are taxes, with some non-tax revenue also
being collected. To finance fiscal deficit and debt, the Philippines relies on both domestic and
external sources.
Fiscal policy during the Marcos administration was primarily focused on indirect tax
collection and on government spending on economic services and infrastructure development.
The first Aquino administration inherited a large fiscal deficit from the previous administration,
but managed to reduce fiscal imbalance and improve tax collection through the introduction of
the 1986 Tax Reform Program and the value added tax. The Ramos administration experienced
budget surpluses due to substantial gains from the massive sale of government assets and strong
foreign investment in years and administrations. The Estrada administration faced a large fiscal
deficit due to the decrease in tax effort and the repayment of the Ramos administration's debt to
contractors and suppliers. During the Arroyo administration, the Expanded Value Added Tax Law
was enacted, national debt-to-GDP ratio peaked, and underspending on public infrastructure and
other capital expenditures was observed.
BSP’s core role is to be the lender of last resort, providing banks with liquidity and
regulatory scrutiny in order to prevent them from failing and creating a panic.
Types of Monetary Policies
Broadly speaking, monetary policies can be categorized as either expansionary or
contractionary:
Expansionary Monetary Policy
If a country is facing high unemployment due to a slowdown or a recession, the monetary
authority can opt for an expansionary policy aimed at increasing economic growth and expanding
economic activity.
As a part of expansionary policy, the monetary authority often lowers the interest rates in
order to promote spending money and make saving it unattractive.
Increased money supply in the market aims to boost investment and consumer spending.
Lower interest rates mean that businesses and individuals can get loans on favorable terms.
Many leading economies around the world have held onto this expansionary approach since the
2008 financial crisis, keeping interest rates at zero or near zero.
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Contractionary Monetary Policy
A contractionary monetary policy increases interest rates in order to slow the growth of
the money supply and bring down inflation.
This can slow economic growth and even increase unemployment but is often seen as
necessary to cool down the economy and keep prices in check.
Tools to Implement Monetary Policy
Central banks use a number of tools to shape and implement monetary policy.
First is the buying and selling of short-term bonds on the open market using newly created
bank reserves. This is known as open market operations. Open market operations target short-
term interest rates such as the federal funds rate. The central bank adds money into the banking
system by buying assets—or removes it by selling assets—and banks respond by loaning the
money more easily at lower rates—or more dearly, at higher rates—until the central bank's
interest rate target is met. Open market operations can also target specific increases in the money
supply to get banks to loan funds more easily by purchasing a specified quantity of assets. This is
the process known as quantitative easing (QE).
The second option is to change the interest rates or the required collateral that the central
bank demands for emergency direct loans to banks in its role as lender-of-last-resort. In the U.S.,
this rate is known as the discount rate. Banks will loan more freely or less freely depending on this
interest rate.
Authorities also can manipulate the reserve requirements. These are the funds that banks
must retain as a proportion of the deposits made by their customers in order to ensure that they
are able to meet their liabilities. Lowering this reserve requirement releases more capital for the
banks to offer loans or to buy other assets. Increasing it curtails bank lending and slows growth.
Unconventional monetary policy has also gained popularity in recent times. During periods
of extreme economic turmoil, such as the financial crisis of 2008, the U.S. Fed loaded its balance
sheet with trillions of dollars in treasury notes and mortgage-backed securities (MBS), introducing
new lending and asset-purchase programs that combined aspects of discount lending, open
market operations, and QE. Monetary authorities of other leading economies across the globe
followed suit.
Central banks have a powerful tool in their ability to shape market expectations by their
public announcements about possible future policies. Central bank statements and policy
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announcements move markets, and investors who guess right about what the central banks will
do can profit handsomely.
Philippine Government Securities
Government Securities (GS) are unconditional obligations of the Republic of the Philippines.
These are relatively free from credit risk because the principal and interest are guaranteed by the
National Government, backed by the full taxing power of the sovereignty as the issuer and DBP as
the selling agent. However, there may be market risks due to changes in the interest rates.
The Philippine Government issues both Peso and US Dollar denominated securities. There are
two kinds of Peso Government Securities (GS): (1) Treasury Bills and (2) Treasury Bonds. Treasury Bills
are obligations with maturity of one year or less, typically issued at a discount to the maturity value.
Treasury Bonds are obligations with maturities ranging from 2 years to 25 years, typically issued at
par with periodic coupon payments to be made up to final maturity. Some bonds may be issued
without coupons and these are known as zero coupon bonds.
As for the dollar denominated GS, it has tenors of up to 25 years. Interest rates are paid semi-
annually based on a fixed coupon rate.
GS are listed on the Bloomberg platform and can be redeemed prior to maturity at prevailing
market rates, subject to availability of buyer. Pero and Dollar Denominated GS are not insured by the
Philippine Deposit Insurance Company (PDIC).
Peso Denominated Securities
Treasury Bills (TBills), Fixed Rate Treasury Notes (FXTNs) and Retail Treasury Bonds (RTB)
Minimum investment – Php100,000.00
Can be used as collateral for loan
Interest rates subject to prevailing market rate
a. Treasury Bills (TBills)
Tenor – 1 year and below
Issued at a discount; subject to 20% final tax
b. Fixed Rate Treasury Notes (FXTNs)
Tenor – 2 to 23 years remaining tenor
Interest – payable semi-annually throughout the tenor if held until maturity; subject to 20% final tax
(except for Tax Exempt Institutions)
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c. Retail Treasury Bonds (RTB)
Tenor – 2 to 24 years remaining tenor
Interest – payable quarterly throughout the tenor if held until maturity; subject to 20% final tax
(except for Tax Exempt Institutions)
US Dollar Denominated Securities
Republic of the Philippines (ROP) Bond
Minimum investment – US$100,000.00
Tenor – 1 to 35 years remaining tenor
Interest – payable semi-annually throughout the tenor if held until maturity
Tax – Non-taxable
What Is Monetary Policy vs. Fiscal Policy?
Monetary policy is enacted by a central bank with the mandate to keep the economy on
an even keel. The aim is to keep unemployment low, protect the value of the currency, and
maintain economic growth at a steady pace. It achieves this mostly by manipulating interest rates,
which in turn raises or lowers borrowing, spending, and savings rates.
Fiscal policy is enacted by a national government. It involves spending taxpayer pesos in order to
spur economic recovery. It sends money, directly or indirectly, to increase spending and turbo-
charge growth.
What Are the Two Types of Monetary Policy?
Broadly speaking, monetary policy is either expansionary or contractionary. An
expansionary policy aims to increase spending by businesses and consumers by making it cheaper
to borrow. A contractionary policy, on the other hand, forces spending lower by making it more
expensive to borrow money.
Depending on which is needed at the time, expansionary or contractionary policies bring
inflation into an acceptable range, keep unemployment at acceptable levels, and maintain the
value of the currency.
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