Monetary policy of the Philippines

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Monetary policy is the monitoring and control of money supply by a central bank, such as
the Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in
the Philippines. This is used by the government to be able to control inflation, and stabilize currency.
Monetary Policy is considered to be one of the two ways that the government can influence the
economy – the other one being Fiscal Policy (which makes use of government spending, and taxes).
[1]
Monetary Policy is generally the process by which the central bank, or government controls the
supply and availability of money, the cost of money, and the rate of interest.

Money Supply Indicator[edit]

The New Generation Philippine Banknotes

Money supply indicators are often found to contain necessary information for predicting future
behavior of prices and assessing economic activity. Moreover, these are used by economists to
confirm their expectations and help forecast trends in consumer price inflation. One can predict, to a
certain extent, the government's intentions in regulating the economy and the consequences that
result from it. For example, the government may opt to increase money supply to stimulate the
economy or the government may opt to decrease money supply to control a possible mishap in the
economy.[2]
These indicators tell whether to increase or decrease the supply. Measures that include not only
money but other liquid assets are called money aggregates under the name M1, M2, M3, etc.
M1: Narrow Money
M1 includes currency in circulation. It is the base measurement of the money supply and includes
cash in the hands of the public, both bills and coins, plus peso demand deposits, tourists’ checks
from non-bank issuers, and other checkable deposits.[3] Basically, these are funds readily available
for spending. Adjusted M1 is calculated by summing all the components mentioned above. [2]
M2: Broad Money[edit]
This is termed broad money because M2 includes a broader set of financial assets held principally
by households.[2] This contains all of M1 plus peso saving deposits (money market deposit
accounts), time deposits and balances in retail money market mutual funds.[3]
M3: Broad Money Liabilities[edit]
Broad Money Liabilities include M2 plus money substitutes such as promissory notes and
commercial papers.[3]
M4: Liquidity Money[edit]
These include M3 plus transferable deposits, treasury bills and deposits held in foreign currency
deposits. Almost all short-term, highly liquid assets will be included in this measure. [3]
Implications[edit]
If the velocity of M1 and M2 money stock has been low, this indicates that there is a lot of money in
the hands of consumers and money is not changing hands frequently. [4]
Generally we would expect that when money supply indicators are growing faster than interest rates
plus growth rate or inflation, whichever is higher, interest rates should possibly be increased. This
should only generally apply when broad measures of money supply growth are higher than narrow
measures, to rule out some of the measurement error issues that could emerge. [5]

Monetary Policy Instruments[edit]

Open Market Operations[edit]
Open Market Operations consist of repurchase and reverse repurchase transactions, outright
transactions, and foreign exchange swaps.

 Repurchase and Reverse Repurchase

This is carried out through the Repurchase Facility and Reverse Purchase Facility of the
Bangko Sentral ng Pilipinas. In Purchase transactions, the Bangko Sentral buys government
securities with a dedication to sell it back at a specified future date, and at a predetermined
interest rate.[6] The BSP's payment increases reserve balances and expands the monetary
supply in the Philippines. On the other hand, in Reverse Repurchase, the government acts
as the seller, and works to decrease the liquidity of money. These transactions usually have
maturities ranging from overnight to one month.

 Outright Transactions
Unlike the repurchase or reverse repurchase, there is no clear intent by the government to
reverse the action of their selling/buying of monetary securities. Thus, this transaction
creates a more permanent effect on our monetary supply. "When the BSP buys securities, it
pays for them by directly crediting its counterparty's Demand Deposit Account with the
BSP."[6] The reverse is done upon the selling of securities.

 Foreign Exchange Swaps

This refers to the actual exchange of two currencies at a specific date, at a rate agreed upon
the deal date and the reverse exchange of the currencies at a farther ate in the future, also
at an interest rate agreed on deal date.[7]
Acceptance of Fixed-Term Deposits[edit]
To expand its liquidity management, the Bangko Sentral introduced this method in 1998.
In the Special Deposits Account, or SDA, consists fixed terms deposits by banks and
institutions affiliated with the BSP.[6]
Standing Facilities[edit]
To increase the volume of credit in the financial system, the Bangko Sentral ng Pilipinas
extends loans, discounts, and advances to banking institutions. "Rediscounting is a
standing credit facility provided by the BSP to help banks meet temporary liquidity needs
by refinancing the loans they extend to their clients." There are two types of
rediscounting in the BSP: the peso rediscounting facility and the Exporter's dollar and
Yen Rediscount Facility.
Reserve Requirements[edit]
In banking institutions, there are required amounts that banks cannot lend out to people.
They always need to maintain a certain balance of money, which are called "reserves".
Once these reserve requirements are changed and are varied, changes in the monetary
supply will be observed greatly.[8]
Two Forms:

1. Regular or Statutory Reserves

2. Liquidity Reserves

Philippine Monetary/Currency Policy[edit]

Bangko Sentral ng Pilipinas[edit]
In accordance with Republic Act No. 265,[9] The Bangko Sentral ng Pilipinas or BSP is
the central monetary authority of the republic of the Philippines. It provides policy
directions in the areas of money, banking and credit and exists to supervise operations
of banks and exercises regulatory powers over non-bank financial institutions. It
keeps aggregate demandfrom growing rapidly with resulting high inflation, or from
growing too slowly, resulting in high unemployment.[10]
The primary objective of BSP's monetary policy is to promote price stability because it
has the sole ability to influence the amount of money circulating in the economy. In
doing so, other economic goals, such as promoting financial stability and achieving
broad-based, sustainable economic growth, are given consideration in policy decision-
making.[11]
Philippine Monetary Framework I: 1980s to early 1990s [edit]
In the past, the BSP followed the monetary aggregate targeting approach to monetary
policy. This approach is based on the assumption that there is a stable and predictable
relationship between money, output and inflation.
In particular, all money aggregates, with the exception of reserve money, are
incorporated with output and interest rate. This means that there is a long-run
relationship between money on one hand and output and interest rate on the other so
that even if there are shocks in the economy, the variables will return to their trend
equilibrium levels.[12]
This means that changes in money supply (on the assumption that velocity is stable
over time) are directly related to price changes or to inflation. Thus, it is assumed that
the BSP is able to determine the level of money supply that is needed given the desired
level of inflation that is consistent with the economy's growth objective. In effect, under
the monetary targeting framework, the BSP controls inflation indirectly by targeting
money supply.[13]
Philippine Monetary Framework II: June 1995 to Present [edit]
The BSP employs a modified framework beginning the second semester of 1995 in
attempt to enhance the effectiveness of the monetary policy by complementing
monetary aggregate targeting with some form of inflation targeting, placing greater
emphasis on price stability.
Certain key modifications include:

 Allows base money levels to go beyond target as long as the inflation rates are met

 An excess of one or more percentage points of inflation over the program induces
mopping up operation by the BSP to bring down base money to the previous
month's level[13]
Under an aggregate targeting framework, the BSP fixes money growth so as to
minimize expected inflation. On the other hand, under the new framework, BSP sets
monetary policy so that price level is not just zero in expectation but is also zero
regardless of latter shocks.[13] Moreover, the framework was changed because BSP
wanted to address the fact that aggregate targeting did not account for the long-run
effects of monetary policy on the economy.
With this approach, the BSP can exceed the monetary targets as long as the actual
inflation rate is kept within program levels and policymakers monitor a larger set of
economic variables in making decisions regarding the appropriate stance of monetary
policy.[12]
Current Approach: Inflation Targeting[edit]
As mentioned earlier, Inflation Targeting requires a public announcement of an inflation
rate that a country will target for the coming years, or in a given period of time. It focuses
on maintaining a low level of inflation, that which is considered to be optimal, or at least
would allow the country to have ample economic growth. Its main desire is to achieve
price stability as the ultimate end goal of the monetary policy. [12] The Philippines formally
adopted Inflation Targeting as the framework for Monetary Policy on January 2002.
The Philippines’ inflation target is measured through the Consumer Price Index (CPI).
For 2009, inflation target has been set to be 3.5 percent, having a 1% tolerance level,
and 4.5 percent for 2010, also having 1% tolerance. Also, the Monetary Board of the
Philippines announced a target of around 4±1 percent from 2012 to 2014. [14]

Monetary Policy Issues[edit]

Exchange Rate[edit]
Exchange rates play a significant role in monetary transmission mechanism and at the
same time, it can have a large impact on inflation rates. Although the BSP has adopted
the inflation targeting approach, it may be tempted to inexplicitly target exchange rate to
achieve its low inflation target. The issue here is the extent of the exchange rate pass-
through or ERPT to domestic prices since higher ERPT would require the BSP to shift
its attention to exchange rate movements to stabilize prices.[15]
Role of Monetary Aggregates[edit]
Since the shift to inflation targeting, BSP has already abandoned monetary aggregates
because its information content has apparently declined in the recent years. Moreover, it
is also assumed that a shift of approach was necessary because money aggregates are
normally not good indicators of future economic policy requirements due to unreliability
of measurement.[15]
Measurement of Inflation and Liquidity Trap[edit]
Since inflation targeting leads to lower and stable inflation rates, more improvement
should then be given to the measurement of the consumer price index since few
percentage points have greater repercussions when rates are low. Errors in CPI
measurement could lead to ineffective and unsuitable monetary policy response by the
BSP which definitely result to detrimental effects to the economy.[15]
Another issue arising from monetary policies is the liquidity trap. This happens when
inflation rate declines too much leading to a threat of deflation. Liquidity trap is defined
as a situation in which there are zero nominal interest rates, persistent deflation and
deflation expectations. In the event this occurs, bonds and money earn the same real
rate of return thus making people indifferent to holding bonds or excess money. [15]
Budget Deficit and External Debts[edit]
Given high budget deficits, the government is concerned about two closely related
issues: it does not want to pay very high interest on its borrowings and it does not want
to crowd out the market. Ideally, the government could raise tax revenues to avoid
borrowing huge sums from the market. However, the government opted to borrow from
the international capital market and though rates are low, these have shorter maturity
and country's outstanding external debt has continued to move towards a less ideal
position.[15]
Fiscal Dominance[edit]
According to the fiscal theory of the price level, it is not the non-interest bearing money
but the total nominal liabilities including interest bearing notes and future fiscal
surpluses that matter for price-level determination. In the absence of fiscal discipline, an
independent central bank such as the BSP cannot guarantee a stable nominal anchor.
In other words, for the BSP to successfully focus on price stability, there must be a
credible commitment on the part of the National Government to reduce total fiscal
deficits by a meaningful amount.[16]
Monetary policy stance remains
appropriate – Tetangco
BSP Governor Amando Tetangco Jr. said the country’s sound macroeconomic fundamentals on the back of the
robust domestic demand and the benign financial environment outweigh the external headwinds from the
planned interest rate increase by the US Federal Reserve. File photo
MANILA, Philippines – The Bangko Sentral ng Pilipinas (BSP) said the country’s monetary policy stance
remains appropriate amid the volatile global financial market brought about by the impending interest rate hike
in the US.

BSP Governor Amando Tetangco Jr. said the country’s sound macroeconomic fundamentals on the back of the
robust domestic demand and the benign financial environment outweigh the external headwinds from the
planned interest rate increase by the US Federal Reserve.

“In our case, domestic conditions are such that you don’t see any need to adjust the stance of monetary policy
at this time given a number of considerations,” he said.

He cited the benign inflation environment as it remained steady at 1.9 percent in July, bringing the average
inflation in the first seven months of the year to 1.4 percent.

The BSP has set an inflation target of between two and four percent from 2016 to 2018.

“Inflation continues to be manageable and we expect it to move within the target range in 2017. This year, it
could end up somewhat below the lower bound,” he added.

Business ( Article MRec ), pagematch: 1, sectionmatch: 1

During the last rate-setting meeting of the BSP’s Monetary Board, authorities slashed its inflation forecast to 1.8
percent instead of two percent this year, and to 2.9 percent instead of 3.1 percent next year.

Furthermore, the BSP chief said the country’s economy continued to grow at a robust pace, posting a faster
gross domestic product (GDP) expansion of seven percent in the second quarter from 6.8 percent in the first
quarter amid the boost from election related spending.

This brought the GDP growth to 6.9 percent in the first half of the year from 5.5 percent in the same period last
year. Economic managers have penned a slower GDP growth of six to seven percent instead of the revised 6.8
to 7.8 percent this year.

Tetangco also took note of the country’s favorable external payments position amid the return of capital inflows
resulting to a net inflow of portfolio investments in recent weeks and months.
Inflation Targeting: The BSP's Approach to Monetary Policy

Download Primer on Inflation Targeting

The primary objective of the BSP's monetary policy is “to promote price stability conducive to a balanced
and sustainable growth of the economy” (Republic Act 7653). The adoption of inflation targeting
framework of monetary policy in January 2002 is aimed at achieving this objective.

Inflation targeting is focused mainly on achieving a low and stable inflation, supportive of the economy’s
growth objective. This approach entails the announcement of an explicit inflation target that the BSP
promises to achieve over a given time period.

The Inflation Target

The government’s inflation target is defined in terms of the average year-on-year change in the
consumer price index (CPI) over the calendar year. In line with the inflation targeting approach to the
conduct of monetary policy, the Development Budget Coordination Committee (DBCC) through its
Resolution No. 2015 – 7 dated 29 December 2015, maintained the current inflation target at 3.0 percent
± 1.0 percentage point for 2016 – 2018.

Consistent with the inflation targeting framework, the Monetary Board announced in July 2010 the BSP’s
shift to a fixed inflation target for the medium term of 4.0 percent ± 1 percentage point for 2012-2014.
The shift to a fixed medium-term inflation target from a variable annual inflation target was approved by
the Development Budget Coordination Committee (DBCC) on 9 July 2010 under DBCC Resolution No.
2010-3.

To achieve the inflation target, the BSP uses a suite of monetary policy instruments in implementing the
desired monetary policy stance. The reverse repurchase (RRP) or borrowing rate is the primary monetary
policy instrument of the BSP.

Other monetary policy instruments include:

encouraging/discouraging deposits under the term deposit auction facility (TDF);

standing liquidity facilities, namely, the overnight lending facility (OLF) and the overnight deposit facility
(ODF);

increasing/decreasing the reserve requirement;

adjusting the rediscount rate on loans extended to banking institutions on a short-term basis against
eligible collateral of banks' borrowers;

outright sales/purchases of the BSP's holding of government securities

1. Reverse repurchase facility

With the implementation of the IRC system, the RRP facility was transformed into an overnight facility
and offered using a fixed-rate and full-allotment method, where individual bidders are awarded a
portion of the total offer depending on their bid size. Fixed-rate, full allotment method will help ensure
that the overnight rate sits close to the BSP policy rate. The features of the O/N RRP facility can be
accessed on the monetary operations page.

2. Acceptance of term deposits

The BSP, like other central banks, offers term deposits as one of the monetary tools to absorb liquidity. In
November 1998, the BSP offered the Special Deposit Accounts (SDA) to banks and trust entities of banks
and non-bank financial institutions. With the adoption of the IRC system in 2016, the SDA facility was
replaced by the term deposit auction facility (TDF).

The TDF is a key liquidity absorption facility used by the BSP for liquidity management and used to
withdraw a large part of the structural liquidity from the financial system to bring market rates closer to
the BSP policy rate. A more detailed discussion on the features of the TDF can be accessed on the
monetary operations page.

3. Standing liquidity facilities

The BSP offers standing liquidity (lending and deposit) windows that help counterparties adjust their
liquidity positions at the end of the day. These standing overnight facilities are available on demand to
qualified counterparties during BSP business hours. The two standing facilities that form the upper and
lower bound of the corridor are set at ± 50 basis points (bps) around the target policy rate (the overnight
RRP rate under the new IRC structure).

4. Rediscounting
The BSP extends discounts, loans and advances to banking institutions in order to influence the volume
of credit in the financial system. The rediscounting facility allows a financial institution to borrow money
from the BSP using promissory notes and other loan papers of its borrowers as collateral.

The rediscounting facility has two categories namely, Peso Rediscount Facility and Exporters Dollar and
Yen Rediscount Facility (EDYRF). The Peso Rediscount Facility interest rates are based on the latest
avialable BSP overnight lending rate plus the applicable term premia per Circular No. 964 dated 27 June
2017. The EDYRF interest rates are based on the 90-day London Inter-Bank Offered Rate for the last
working day of the immediately preceding month plus 200 basis points plus the applicable term premia
for loan maturities exceeding 90 days pursuant to Circular No. 807 dated 15 August 2013.

5. Reserve requirements

Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that
banks must set aside in deposits with the BSP which they cannot lend out, or where available through
reserve-eligible government securities. Changes in reserve requirements have a significant effect on
money supply in the banking system, making them a powerful means of liquidity management by the
BSP.

Reserve requirements are imposed on the peso liabilities of universal/commercial banks (UBs/KBs), thrift
banks (TBs), rural banks (RBs) and cooperative banks (Coop Banks), and non-bank financial institutions
with quasi-banking functions (NBQBs). Reservable liabilities include demand, savings, time deposit and
deposit substitutes (including long-term non-negotiable tax-exempt certificates of time deposit or
LTNCTDs)

The existing reserve requirement ratios vary across bank types and liabilities. The current headline
reserve requirement ratio of 20 percent is imposed on certain liabilities of UBs/KBs and NBQBs.
Previously, the eligible forms of compliance to the reserve requirements included banks' deposits in their
demand deposit account (DDA) with the BSP, reserve-eligible government securities, and vault cash.
Effective on the reserve week beginning on 6 April 2012, the BSP excluded vault cash (for banks) and
demand deposits (NBQBs) as eligible forms of reserve requirement compliance. 4 At the same time, the
BSP unified the existing statutory reserve requirement and liquidity reserve requirement into a single set
of reserve requirement as well as discontinued the renumeration of the unified reserve requirements.

Monetary Policy - Glossary and Abbreviations

Base Money (BM) – the sum of the reserve money (RM), reserve-eligible government securities, liquidity
reserves and reserve deficiency of banks. 1

Consumer Price Index (CPI) – represents the average price for a given period of a standard basket of
goods and services consumed by a typical Filipino family. This standard basket contains hundreds of
consumption items (such as food products, clothing, water and electricity) whose price movements are
monitored to determine the overall change in the CPI, or the level of inflation (See also Inflation Rate).

Demand-Pull Factors of Inflation – pressures on inflation caused by relatively higher demand compared
to the available supply of goods and services. Usually, when people, business or the government receive
more income, realize capital gains or obtain easier access to credits, the overall demand for goods and
services may increase. This would lead to increased prices, assuming the supply of goods and services is
not able to adjust quickly enough to meet the higher demand. In addition, supply shocks in the economy
that, either increase the costs of raw materials or curtail supply or both could result in second-round
effects that, in turn, may lead to higher demand-side price pressures. Higher oil and agricultural
commodity prices, for instance, may eventually affect the price- and wage-setting behavior of economic
agents, which could then lead to second-round price pressures from the demand side.

Explanation Clauses - the predefined set of acceptable circumstances under which an inflation targeting
central bank may fail to achieve its inflation target. Such circumstances recognize the fact that there are
limits to the effectiveness of monetary policy and that deviations from the inflation target may
sometimes occur because of factors beyond the control of the central bank. Under the inflation targeting
framework of the BSP, these circumstances include price pressures arising from: (a) volatility in the prices
of agricultural products; (b) natural calamities or events that affect a major part of the economy; (c)
volatility in the prices of oil products; (d) significant government policy changes that directly affect prices
such as changes in the tax structure, incentives and subsidies.

Inflation Rate - the rate of change in the weighted average prices of goods and services typically
purchased by consumers. The weights of the goods and services are based on their corresponding share
to the Consumer Price Index (CPI) basket, i.e., the standard basket of goods and services purchased by a
typical household. In the Philippines, the composition of the CPI basket is determined from the Family
Income and Expenditure Survey (FIES) periodically conducted by the National Statistics Office (NSO).
Inflation is typically defined as the annual percentage change in the CPI. It indicates how fast or slow the
CPI increases or decreases.

• Headline Inflation – the rate of change in the weighted average prices of all goods and services in
the CPI basket.

• Core Inflation – An alternative measure of inflation that eliminates transitory effects on the CPI,
core inflation removes certain components of the CPI basket that are subject to volatile price
movements, such as food and energy, and other items affected by supply side factors, the price changes
from which are not within the control of monetary policy.

Official Definition - This refers to the rate of change in the CPI which excludes the following items/
commodity groups: rice, corn, fruits and vegetables, and fuel items (gas, liquefied petroleum gas (LPG),
kerosene, gasoline and diesel), which together represent 18.4 percent of the CPI basket. Core inflation
data for 2001-2002 are BSP estimates while the data starting January 2003 are the official National
Statistics Office (NSO) figures.

BSP’s Alternative Measures of Core Inflation:

o Net of Selected Volatile Items - This measure refers to the rate of change in the CPI which
excludes the following items/ commodity groups: educational services, fruits and vegetables, personal
services, rentals, recreational services, rice, and corn which together represent 37.6 percent of the CPI
basket.

o Trimmed Mean - represents the average inflation of the (weighted) middle 70 percent in a
lowest-to-highest ranking of year-on-year inflation rates for all CPI components.

o Weighted Median - represents the middle inflation (corresponding to a cumulative CPI weight of
50 percent) in a lowest-to-highest ranking of year-on-year inflation rates.

Inflation Expectations – the perceived rate of change, trends and movements of the prices of goods and
services in the economy. Measures of inflation expectations include survey-based consumer and
business expectations of inflation and inflation forecasts of private analysts, among others.

Inflation Target – level of inflation which the BSP aims to achieve over a given period under the inflation
targeting framework. The government’s inflation target is an annual target, currently expressed in terms
of a point target (with a tolerance interval of ± 1 percentage point) and is set jointly by the BSP and the
government through an inter-agency body, the Development Budget Coordination Committee (DBCC),
although the responsibility of, and accountability in, achieving the target rests primarily on the BSP.

Inflation Targeting (IT) – a framework for monetary policy that focuses mainly on achieving price stability
as the ultimate objective of monetary policy. The IT approach entails the announcement of an explicit
inflation target that the monetary authority promises to achieve over a policy horizon of two years.

Interest Rates – the cost of borrowing money or the amount paid for lending money expressed as a
percentage of the principal.

Interest Rate Differential - the difference or margin between interest rates such as the difference
between domestic and foreign interest rates.

M1 or Narrow Money – consists of currency in circulation (or currency outside depository corporations)
and peso demand deposits.

M2 or Broad Money – consists of M1 plus peso savings and time deposits.

M3 or Broad Money Liabilities – consists of M2 plus peso deposit substitutes, such as promissory notes
and commercial papers (i.e., securities other than shares included in broad money).

M4 - consists of M3 plus transferable and other deposits in foreign currency.

Monetary Aggregate Targeting – an approach to monetary policy whereby the central bank adjusts its
monetary policy instruments to control the level of monetary aggregates. This approach is based on the
assumption that there is a stable and predictable relationship between money on the one hand, and
output and inflation on the other hand. This means that the reaction of inflation to changes in money
supply is stable over time and is, therefore, predictable. The approach assumes that the monetary
authority is able to determine the level of money supply that is needed given the desired level of
inflation that is consistent with the economy's growth objective. In effect, the monetary authority
influences inflation indirectly by targeting the money supply.

Monetary Policy – measures or actions taken by the central bank to influence the general price level and
the level of liquidity in the economy. Monetary policy actions of the BSP are aimed at influencing the
timing, cost and availability of money and credit, as well as other financial factors, for the main objective
of stabilizing the price level.

o Expansionary Monetary Policy – 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. Examples are the lowering of policy interest rates and the reduction in reserve
requirements. 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.

o Contractionary Monetary Policy - 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. Examples of this are increases in policy interest rates and reserve requirements.
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.

Liquidity reserves - refers to the option given to banks in complying with the reserve requirement,
whereby bonds deposited in the reserve deposit account (RDA) facility are considered as compliance
with the reserve requirement. 2

Monetary Policy Instruments –the various instruments used by the BSP to achieve the desired level of
money supply. These include (a) raising/reducing the BSP's policy interest rates; (b)
increasing/decreasing the reserve requirement; (c) encouraging/discouraging deposits in the special
deposit account (SDA) facility by banks and trust entities of BSP-supervised financial institutions; (d)
increasing/decreasing its rediscount rate on loans extended to banking institutions on a short-term basis
against eligible collaterals of banks’ borrowers; and (e) outright sales/purchases of the BSP’s holdings of
government securities. The BSP’s primary monetary policy instruments are the overnight reverse
repurchase (borrowing) rate and the overnight repurchase (lending) rate.

Moral Suasion – the influence which the central bank 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.

Open Market Operations (OMO) – the sale or purchase of government securities by the BSP to withdraw
liquidity from or inject liquidity into the system.

Quasi-money – the sum of savings and time deposits

Rediscounting – 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

Repurchase (RP) Rate - the policy interest rate at which the BSP lends to banks with government
securities as collateral

Reserve Deposit Account (RDA) – The reserve deposit account (RDA) is a deposit facility with the BSP
designed to facilitate the adoption of the change in the banks’ mode of compliance with the liquidity
reserve requirement, pursuant to Circular No. 539 which became effective on 25 August 2006. The
liquidity reserve requirement consisted of market-yielding government securities purchased directly
from the BSP. The RDA, which eventually replaced government securities as a form of compliance with
the liquidity reserves, allows banks to keep a portion of their reserves in the form of a three-month term
deposit in the RDA maintained with the BSP. The Treasury Department also has the option of offering
RDA with 6-and 12-month tenors, with interest rate at one-half percent (1/2%) below the prevailing
market rate for comparable government securities. Pre-termination of RDAs is allowed, subject to a
reduction in applicable interest rates, as prescribed by the Treasury Department.

Reserve Money (RM) – the sum of currency in circulation and reserves of banks which include cash in
banks’ vault and reserve balances or deposits with the BSP including banks’ balances under the reserve
deposit account (RDA).

Reserve Requirement – refers to the proportion of banks’ deposits and deposit substitute liabilities that
banks are required to hold as reserves

Regular (statutory) reserves - pertain to the proportion of deposits and deposit substitute liabilities,
which must be held as deposits with the BSP in part, with the remaining balance allowed to be kept in
banks' vaults as cash or as reserve-eligible government securities

Regular Reserves – the proportion of deposits and deposit substitute liabilities, a certain fixed portion of
which must be held as deposits with the BSP, with the balance kept in banks’ vaults as cash or eligible
reserves.

Reverse Repurchase (RRP) Rate – the policy interest rate at which the BSP borrows from banks with
government securities as collateral.
Special Deposit Accounts – Fixed-term deposits by banks and trust entities of BSP-supervised financial
institutions with the BSP. These deposits were introduced in November 1998 to expand the BSP's toolkit
for liquidity management. In April 2007, the BSP expanded the access to the SDA facility to allow trust
entities of financial institutions under BSP supervision to deposit in the facility.

Supply Shocks to Inflation – pressures on inflation resulting from shortages in supply and increases in the
cost of production without a corresponding expansion in output. Examples of these are bad weather,
natural calamities and disasters; wage increases not matched by higher productivity of labor; hikes in
international oil prices; increases in prices of imported raw materials; and hikes in rental rates. These
tend to limit or decrease supply, and, assuming no decline in demand for goods and services, push prices
up. (Conversely, an oversupply of commodities tends to induce the opposite effect on prices.)

Transmission Mechanism of Monetary Policy – process by which monetary policy actions affect economic
and financial variables. This mechanism describes the various channels, as well as the length of time,
through which monetary policy actions affect the real economy, particularly inflation and output.

Treasury Bill Rate – the yield on short-term debt instruments issued by the National Government (NG)
(the primary market) for the purpose of generating f Monetary Policy - Glossary and Abbreviations

Base Money (BM) – the sum of the reserve money (RM), reserve-eligible government securities, liquidity
reserves and reserve deficiency of banks. 1

Consumer Price Index (CPI) – represents the average price for a given period of a standard basket of
goods and services consumed by a typical Filipino family. This standard basket contains hundreds of
consumption items (such as food products, clothing, water and electricity) whose price movements are
monitored to determine the overall change in the CPI, or the level of inflation (See also Inflation Rate).

Demand-Pull Factors of Inflation – pressures on inflation caused by relatively higher demand compared
to the available supply of goods and services. Usually, when people, business or the government receive
more income, realize capital gains or obtain easier access to credits, the overall demand for goods and
services may increase. This would lead to increased prices, assuming the supply of goods and services is
not able to adjust quickly enough to meet the higher demand. In addition, supply shocks in the economy
that, either increase the costs of raw materials or curtail supply or both could result in second-round
effects that, in turn, may lead to higher demand-side price pressures. Higher oil and agricultural
commodity prices, for instance, may eventually affect the price- and wage-setting behavior of economic
agents, which could then lead to second-round price pressures from the demand side.

Explanation Clauses - the predefined set of acceptable circumstances under which an inflation targeting
central bank may fail to achieve its inflation target. Such circumstances recognize the fact that there are
limits to the effectiveness of monetary policy and that deviations from the inflation target may
sometimes occur because of factors beyond the control of the central bank. Under the inflation targeting
framework of the BSP, these circumstances include price pressures arising from: (a) volatility in the prices
of agricultural products; (b) natural calamities or events that affect a major part of the economy; (c)
volatility in the prices of oil products; (d) significant government policy changes that directly affect prices
such as changes in the tax structure, incentives and subsidies.

Inflation Rate - the rate of change in the weighted average prices of goods and services typically
purchased by consumers. The weights of the goods and services are based on their corresponding share
to the Consumer Price Index (CPI) basket, i.e., the standard basket of goods and services purchased by a
typical household. In the Philippines, the composition of the CPI basket is determined from the Family
Income and Expenditure Survey (FIES) periodically conducted by the National Statistics Office (NSO).
Inflation is typically defined as the annual percentage change in the CPI. It indicates how fast or slow the
CPI increases or decreases.

Headline Inflation – the rate of change in the weighted average prices of all goods and services in the CPI
basket.

Core Inflation – An alternative measure of inflation that eliminates transitory effects on the CPI, core
inflation removes certain components of the CPI basket that are subject to volatile price movements,
such as food and energy, and other items affected by supply side factors, the price changes from which
are not within the control of monetary policy.

Official Definition - This refers to the rate of change in the CPI which excludes the following items/
commodity groups: rice, corn, fruits and vegetables, and fuel items (gas, liquefied petroleum gas (LPG),
kerosene, gasoline and diesel), which together represent 18.4 percent of the CPI basket. Core inflation
data for 2001-2002 are BSP estimates while the data starting January 2003 are the official National
Statistics Office (NSO) figures.

BSP’s Alternative Measures of Core Inflation:

Net of Selected Volatile Items - This measure refers to the rate of change in the CPI which excludes the
following items/ commodity groups: educational services, fruits and vegetables, personal services,
rentals, recreational services, rice, and corn which together represent 37.6 percent of the CPI basket.

Trimmed Mean - represents the average inflation of the (weighted) middle 70 percent in a lowest-to-
highest ranking of year-on-year inflation rates for all CPI components.
Weighted Median - represents the middle inflation (corresponding to a cumulative CPI weight of 50
percent) in a lowest-to-highest ranking of year-on-year inflation rates.

Inflation Expectations – the perceived rate of change, trends and movements of the prices of goods and
services in the economy. Measures of inflation expectations include survey-based consumer and
business expectations of inflation and inflation forecasts of private analysts, among others.

Inflation Target – level of inflation which the BSP aims to achieve over a given period under the inflation
targeting framework. The government’s inflation target is an annual target, currently expressed in terms
of a point target (with a tolerance interval of ± 1 percentage point) and is set jointly by the BSP and the
government through an inter-agency body, the Development Budget Coordination Committee (DBCC),
although the responsibility of, and accountability in, achieving the target rests primarily on the BSP.

Inflation Targeting (IT) – a framework for monetary policy that focuses mainly on achieving price stability
as the ultimate objective of monetary policy. The IT approach entails the announcement of an explicit
inflation target that the monetary authority promises to achieve over a policy horizon of two years.

Interest Rates – the cost of borrowing money or the amount paid for lending money expressed as a
percentage of the principal.

Interest Rate Differential - the difference or margin between interest rates such as the difference
between domestic and foreign interest rates.

M1 or Narrow Money – consists of currency in circulation (or currency outside depository corporations)
and peso demand deposits.

M2 or Broad Money – consists of M1 plus peso savings and time deposits.

M3 or Broad Money Liabilities – consists of M2 plus peso deposit substitutes, such as promissory notes
and commercial papers (i.e., securities other than shares included in broad money).
M4 - consists of M3 plus transferable and other deposits in foreign currency.

Monetary Aggregate Targeting – an approach to monetary policy whereby the central bank adjusts its
monetary policy instruments to control the level of monetary aggregates. This approach is based on the
assumption that there is a stable and predictable relationship between money on the one hand, and
output and inflation on the other hand. This means that the reaction of inflation to changes in money
supply is stable over time and is, therefore, predictable. The approach assumes that the monetary
authority is able to determine the level of money supply that is needed given the desired level of
inflation that is consistent with the economy's growth objective. In effect, the monetary authority
influences inflation indirectly by targeting the money supply.

Monetary Policy – measures or actions taken by the central bank to influence the general price level and
the level of liquidity in the economy. Monetary policy actions of the BSP are aimed at influencing the
timing, cost and availability of money and credit, as well as other financial factors, for the main objective
of stabilizing the price level.

Expansionary Monetary Policy – 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. Examples are the lowering of policy interest rates and the reduction in reserve
requirements. 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.

Contractionary Monetary Policy - 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. Examples of this are increases in policy interest rates and reserve requirements.
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.

Liquidity reserves - refers to the option given to banks in complying with the reserve requirement,
whereby bonds deposited in the reserve deposit account (RDA) facility are considered as compliance
with the reserve requirement. 2
Monetary Policy Instruments –the various instruments used by the BSP to achieve the desired level of
money supply. These include (a) raising/reducing the BSP's policy interest rates; (b)
increasing/decreasing the reserve requirement; (c) encouraging/discouraging deposits in the special
deposit account (SDA) facility by banks and trust entities of BSP-supervised financial institutions; (d)
increasing/decreasing its rediscount rate on loans extended to banking institutions on a short-term basis
against eligible collaterals of banks’ borrowers; and (e) outright sales/purchases of the BSP’s holdings of
government securities. The BSP’s primary monetary policy instruments are the overnight reverse
repurchase (borrowing) rate and the overnight repurchase (lending) rate.

Moral Suasion – the influence which the central bank 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.

Open Market Operations (OMO) – the sale or purchase of government securities by the BSP to withdraw
liquidity from or inject liquidity into the system.

Quasi-money – the sum of savings and time deposits

Rediscounting – 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

Repurchase (RP) Rate - the policy interest rate at which the BSP lends to banks with government
securities as collateral

Reserve Deposit Account (RDA) – The reserve deposit account (RDA) is a deposit facility with the BSP
designed to facilitate the adoption of the change in the banks’ mode of compliance with the liquidity
reserve requirement, pursuant to Circular No. 539 which became effective on 25 August 2006. The
liquidity reserve requirement consisted of market-yielding government securities purchased directly
from the BSP. The RDA, which eventually replaced government securities as a form of compliance with
the liquidity reserves, allows banks to keep a portion of their reserves in the form of a three-month term
deposit in the RDA maintained with the BSP. The Treasury Department also has the option of offering
RDA with 6-and 12-month tenors, with interest rate at one-half percent (1/2%) below the prevailing
market rate for comparable government securities. Pre-termination of RDAs is allowed, subject to a
reduction in applicable interest rates, as prescribed by the Treasury Department.
Reserve Money (RM) – the sum of currency in circulation and reserves of banks which include cash in
banks’ vault and reserve balances or deposits with the BSP including banks’ balances under the reserve
deposit account (RDA).

Reserve Requirement – refers to the proportion of banks’ deposits and deposit substitute liabilities that
banks are required to hold as reserves

Regular (statutory) reserves - pertain to the proportion of deposits and deposit substitute liabilities,
which must be held as deposits with the BSP in part, with the remaining balance allowed to be kept in
banks' vaults as cash or as reserve-eligible government securities

Regular Reserves – the proportion of deposits and deposit substitute liabilities, a certain fixed portion of
which must be held as deposits with the BSP, with the balance kept in banks’ vaults as cash or eligible
reserves.

Reverse Repurchase (RRP) Rate – the policy interest rate at which the BSP borrows from banks with
government securities as collateral.

Special Deposit Accounts – Fixed-term deposits by banks and trust entities of BSP-supervised financial
institutions with the BSP. These deposits were introduced in November 1998 to expand the BSP's toolkit
for liquidity management. In April 2007, the BSP expanded the access to the SDA facility to allow trust
entities of financial institutions under BSP supervision to deposit in the facility.

Supply Shocks to Inflation – pressures on inflation resulting from shortages in supply and increases in the
cost of production without a corresponding expansion in output. Examples of these are bad weather,
natural calamities and disasters; wage increases not matched by higher productivity of labor; hikes in
international oil prices; increases in prices of imported raw materials; and hikes in rental rates. These
tend to limit or decrease supply, and, assuming no decline in demand for goods and services, push prices
up. (Conversely, an oversupply of commodities tends to induce the opposite effect on prices.)
Transmission Mechanism of Monetary Policy – process by which monetary policy actions affect economic
and financial variables. This mechanism describes the various channels, as well as the length of time,
through which monetary policy actions affect the real economy, particularly inflation and output.

Treasury Bill Rate – the yield on short-term debt instruments issued by the National Government (NG)
(the primary market) for the purpose of generating funds. Treasury bills come in maturities of 91, 182
and 364 day

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1 Liquidity reserves now take the form of deposits with RDA, which in turn is already counted as part of
Reserve Money.

2 Originally, these consisted of market-yielding GS purchased directly from the BSP under Circular No. 10
dated 29 December 1993.unds. Treasury bills come in maturities of 91, 182 and 364 day

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1 Liquidity reserves now take the form of deposits with RDA, which in turn is already counted as part of
Reserve Money.

2 Originally, these consisted of market-yielding GS purchased directly from the BSP under Circular No. 10
dated 29 December 1993.