‘Loose monetary policy may stoke inflation’

MANILA, Philippines — The Bangko Sentral ng Pilipinas (BSP) should consider the risks of increasing the country’s money supply as these could aggravate existing inflationary pressures, according to the Congressional Policy and Budget Research Department (CPBRD).

In a report, the think tank of the House of Representatives said money supply and inflation are deeply intertwined based on the evidence presented.

“Policymakers committed to managing inflation are thus advised to carefully consider the risks inherent in insisting on expansionary monetary policy, particularly in the near future,” the CPBRD said.

It said that further growth in the financial system’s money supply could aggravate existing inflationary pressures and heighten risks of stagflation, or the phenomenon where a country experiences slow economic growth, high unemployment rates and elevated inflation.

The report explained that increases in money supply have led to higher inflation rates as there exists a significant and positive relationship between changes in money supply three quarters ago and the most recent change in the consumer price index.

“It is worth emphasizing that quarter-to-quarter changes in the money supply are measured in millions of pesos. This result suggests that expansionary monetary policy elicits a delayed but significant effect on prices,” the CPBRD said.

To mitigate the risks of expansionary monetary policy, the CPBRD said policymakers should consider adopting a rule-based monetary policy framework where money supply is indexed to economic growth.

“This strategy is expected to significantly enhance the transparency and credibility of the BSP. This, in turn, enhances the capacity of the BSP to temper inflation as well as expectations regarding inflation,” the think tank said.

“Taking expansionary monetary policy off of the table removes the capacity of the government to pursue short-run economic gains (i.e., pump-priming through the printing of money) but has the expected benefit of stabilizing prices, smoothing the business cycle, and sustaining long-run economic growth,” it added.

Expansionary monetary policy aims to increase domestic demand and stimulate economic growth. It is implemented by a central bank that uses its tools to increase the money supply, lower interest rates as well as stimulate consumer spending and business investment.

On the other hand, contractionary monetary policy is intended to reduce the rate of monetary expansion to tame inflation. Central banks typically raise interest rates to limit active money circulation, quell speculation and curb inflation.

After the economy posted a 7.6-percent gross domestic product (GDP) growth and inflation quickened to multi-year highs in 2022, the BSP tightened interest rates by 450 basis points from May 2022 to October 2023.

Since the last 25-basis-point hike in October last year, the BSP Monetary Board has held policy rates steady and kept the key interest rate at a 17-year high of 6.50 percent. The central bank has been keeping a restrictive rate environment amid possible risks to the inflation outlook.

However, inflation has been within the two to four percent target for seven straight months. Inflation eased to 3.7 percent in June from 3.9 percent in May.

During the BSP’s policy review in June, BSP Governor Eli Remolona Jr. said the risks to the inflation outlook have shifted to the downside. He added that if sustained, an improvement in the inflation outlook would allow the BSP more room to consider a less restrictive monetary policy stance.

Meanwhile, increasing the existing budget deficit through expansionary monetary policy also pose considerable risks to economic growth and price stability, the CPBRD said.

“Instead, policymakers can look towards either moderating the size of the national budget, enhancing tax efficiency, or broadening its tax base in order to fund government expenditures. Strengthening fiscal discipline can be viewed to be indispensable in managing growing inflation and stagflation risks,” it added.