BSP maintains credibility in volatile times – Medalla – Manila Bulletin
Bangko Sentral ng Pilipinas (BSP) Governor Felipe M. Medalla is confident that amid high inflation and the exchange rate hitting a 17-year low, the central bank’s credibility is under attack. intact and the market is assured of an appropriate policy at this time.
“Effective communication is essential to credibly assure the markets that the fundamentals are intact and that appropriate policy measures will be taken when necessary in a pre-emptive manner. In this sense, it was emphasized that central bank communication can be used to manage expectations by both ‘creating news’ and ‘reducing noise’,” Medalla said on Tuesday, July 12, during the BSP’s two-day virtual international research fair. , its second since its creation in 2021.
Medalla, who was named BSP’s sixth governor this month after 11 years as a member of the Monetary Council, said he believed central banks, while addressing “immediate concerns”, must also “keep a eye and dedicate resources to ensure that we build our credibility, skills, and technology capabilities to be up to the bespoke task.
Medalla said the BSP juggles a lot of information and data in its inflation targeting mandate and must balance inflation expectations with the growth path. “While global challenges, such as climate change and food security, are primarily the purview of tax authorities, they affect our predictions of the trajectories of the variables of interest and their long-term values. This, of course, has implications on our policy decisions So central banks would do well to support other things that are important in operations – like improving big data capacity, and of course, developing our staff and possibility for regulated entities to participate in green funds,” he said.
At its core, Medalla said policy-making remains driven by forecasts of GDP growth and inflation rates — “how our policies may affect them, and the lag between policies and their effects.”
“We know of course that our forecasts can be wrong, sometimes very wrong,” he said, recalling 2015 and 2016 when inflation was very low at 0.7% and 1.3% against the target of 2 to 4%. Next, Medalla said the market accepts that the BSP need not react via rate action as supply shocks are transitory in nature.
In 2022, after two years of the pandemic and now the continued impact of the war in Ukraine on global oil and non-oil prices, as well as interest rate increases in major economies such as the United States United and Europe, the BSP chief said the current situation is “much more difficult” and “people don’t want to hear that our tools aren’t very good at dealing with supply shocks.”
The BSP is managing an inflation rate that rose to 6.1% in June and by all indications it continues to rise, well beyond its target of 2-4% through 2023. The peso depreciated to the P56 level this month and coupled with high inflation, convinced the BSP to raise benchmark rates by 25 basis points (bps) in May and June. Medalla bluntly signaled to the market that it would likely raise the key rate by 2.5% to 3% next month.
“They (the market) don’t care who; they want someone to fix the problem. They, or at least the loudest part of the gallery, also want us to raise interest rates much more in response to what was initially unanticipated US monetary policy. In short, they don’t want us to be like the classic version of an IT central bank (targeting inflation),” Medalla said.
“So I guess we have a lot of education to do for the markets to accept volatility and live with it. We have to do more and more of it gradually over time. When I asked some people, ‘What is the optimal volatility?’ They always tell me, ‘More than you had yesterday,’” he said.
Medalla added that the direction of inflation expectations is only half the battle – “particularly during episodes of high inflation when central banks cannot afford to appear reckless or inattentive. Of course, we need to be transparent so that we can explain why when we’re wrong.
“When detected early enough, the right policies can bring inflation expectations back towards inflation targets. By the way, our studies show that private sector forecasts follow our forecasts with a lag – a very, very short lag. We clearly don’t want to lose that,” he said. “But we have to admit that inflation expectations don’t just depend on monetary policy and even fiscal policy, but on what happens outside the Philippines. I repeat, safeguarding price stability is not only an essential condition for preserving macroeconomic stability; it can also contribute to higher economic growth.
The BSP uses all types of forward guidance to help calm markets by providing credible and clear direction for monetary policy, particularly when conditions change with the normalization of policies in economies.
The BSP’s Monetary Council, its decision-making body, is known for giving purely qualitative forward guidance which are broad statements that provide insight into the likely future path of monetary policy.
Forward guidance is a policy tool that improves the effectiveness of monetary policy by guiding interest rate expectations and reducing market uncertainty. The most common BSP forecast is when they say that the central bank “stands ready to adjust its policy settings if necessary to ensure price stability and financial stability conducive to a sustainable economic recovery.”
Unlike purely qualitative forward guidance, foreign central banks would often use state contingent forward guidance which has specific conditions that are expected to occur before any monetary policy action, such as when the rate of inflation reaches a certain level.
Time-based forward guidance, on the other hand, uses predetermined dates before adjusting monetary policy settings. This policy guidance approach would take action in doses according to the announced period.
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