Central banking in the Philippines: from inflation targeting to financing development

Abstract

The Philippines’ shift in monetary policy from ‘monetary targeting’ in the 1980s and 1990s to ‘inflation targeting’ (IT) in 2002 has so far brought in a more ‘benign’ monetary policy that is more sensitive to output objectives. This result is mainly due to low inflation rates in the Philippines following the downward trend of world inflation in recent years. Whether this ‘benign’ policy will continue faces a critical test if inflationary pressures were to return. The problem is that both the monetary and IT regimes are based on a demand explanation of inflation that blames inflation on overexpansion of money and credit. The evidence for the Philippines shows the inflation experience had been mostly a supply‐led and cost–push phenomenon. The paper documents that, even with a lax monetary policy, the macroeconomy is still not able to adequately increase lending to the private sector amid fiscal difficulties; this contributes to lagging investment and employment creation. Monetary policy is not independent from the other macro sectors as well as the real and external sectors of the economy. This paper therefore proposes alternative monetary policies to IT that take into consideration the bigger and more complex role of monetary policy in an economy that requires a more development‐promoting program.