BSP to expand monetary policymaking

Published April 12, 2021, 6:00 AM

by Lee C. Chipongian

The Bangko Sentral ng Pilipinas (BSP) will be adding the fiscal and external sectors such as the balance of payments to the list of variables in its policy analysis model for its future decisions and regular forecasting exercises.

This will also give BSP a better handle on the short-term outlook for the economy, inflation, interest rates and foreign exchange.

In announcing the formal adoption of the Policy Analysis Model for the Philippines (PAMPh), BSP Governor Benjamin E. Diokno said the PAMPh re-specified and recalibrated the Macroeconomic Model of the Philippines (MMPH) that the BSP has been using since 2013.

Updates in the current PAMPh version include the disaggregation of headline inflation into its core, food, and energy components to more adequately capture the demand and supply sources of inflation.

Diokno said the model, which will use quarterly data, also included as components the business process outsourcing receipts and Overseas Filipinos remittances as drivers of aggregate demand and exchange rate to reflect these features of the economy.

The PAMPh has re-defined the structure of interest rates based on the policy rate and market rate to ensure a more representative transmission of monetary policy to the economy and also re-defined the real exchange rate relative to the US dollar as the trade-weighted real effective exchange rate, and re-calibration of parameters, the BSP chief added.

However the current PAMPh, limited in its “predictive power” for near and medium-term horizons, do not as yet include some sectors of the economy such as the fiscal and external sectors, but could capture the “idiosyncratic features of the Philippine economy and thus, aid in BSP’s policy analysis.”

Diokno said policy models are maintained, routinely reviewed and refined if necessary by the BSP’s Department of Economic Research (DER). “These models are primarily used for macroeconomic forecasting, scenario building and policy simulation exercises,” he said during his weekly online “GBED Talks”.

“These models and their essence are analytical tools that helps BSP implement a forward looking monetary policy framework, simulate policies based on various scenarios and thus guide us in formulating the appropriate monetary policy action,” he said.

He added that their policy models in themselves are not buffers or shields against future shocks. “Rather the models help the BSP to get a sense of the future operating environment and possible risks or shocks that would threaten the said environment that is our baseline view of inflation and growth prospects and consider the possible mix of policy actions to take under the circumstances,” he said.

In a BSP paper, DER officials said the fiscal and external sectors could be incorporated later as extensions to the PAMPh model. But, it said that there is a trade-off between model size and model tractability that should be “carefully navigated” for regular forecasting exercises.

“Nonetheless, PAMPh at its current state can be used to analyze the key features of the Philippine economy for monetary policy analysis and support policy advice,” according to the report.

Diokno said the PAMPh is a useful guide for monetary policymaking because of the model’s focus on key macroeconomic relationships that are “most relevant for monetary policy, and can generate a medium-term policy rate path consistent with the achievement of the government’s inflation target” of two-four percent.

The PAMPh also focuses on transmission channels of monetary policy such as the interest rate, the exchange rate and the expectations.

“Changes in the policy rate affect market interest rates which help determine the real interest rate. For example, in periods of below target inflation rate and slow economic growth, a reduction in the policy rate could encourage economic agents to consume more or invest more,” explained Diokno.

Policy rate actions have an impact on the exchange rate. A cut in rate can lead to peso depreciation. “In turn, the peso depreciation could directly affect inflation by raising the prices of imported commodities. Moreover, a weakening of local currency suggests improved external competitiveness which could raise exports,” noted Diokno.

As for the expectations channel relating to economic growth, inflation, and interest rate outlook, he said this is crucial in encouraging confidence in the BSP. “A credible central bank plays a crucial role in economic agents’ decisions on consumption, investments, and savings,” said Diokno.

The PAMPh is based on the Forecasting and Policy Analysis System (FPAS) developed by the International Monetary Fund. The FPAS is the standard system adopted by many inflation-targeting central banks such as the BSP.