(DP 2001-05) What Drives Monetary Policy?

Abstract

Under its charter, the mandated duty of the BSP is to maintain price stability, yet there are many ways of translating this objective into a workable framework for monetary policy. Under the monetarist framework that forms the basis of the IMF's financial programming approach, including its program with the Philippine Government, this means that controlling the growth of the money supply is key to controlling inflation. This is the basic approach that has been in use in the Philippines since the mid-1980s.

This study is an attempt to understand how monetary policy is conducted today, if and how it differs from the manner it was conducted in the past, whether monetary authorities are faithful to the tenets of the theories they say underlie their framework, and whether any lessons have been learned at least since the onset of the Asian financial crisis in July 1997.

The basic finding is that the framework being used by the monetary authorities currently cannot be described as monetarist in the tradition of QTM. The results of the Granger tests performed, albeit a crude form of empirical testing, tend to support the hypothesis that what drives monetary policy in this country is basically concerns over the exchange rate. It appears that the authorities use monetary growth reactively, to set a floor on the rate of peso depreciation directly, as a way of ultimately control the rate of inflation.