Has the BSP rate hike failed?

Since established in 1993 the Bangko Sentral ng Pilipinas (BSP) has gained our respect for policy decisions that have been thoughtfully considered and without undue haste. However, our confidence in the decision-making process has been shaken in these last months.

Inflation can be caused by a disruption in the balance between supply and demand. A shortage in the supply of a consumable commodity for whatever reason usually works itself out. Either the situation that caused the shortage ends or producers increase their output.

A rapid increase in demand will make prices go higher, as the supply cannot keep up. This often happens when an economy grows too fast, causing demand to outstrip supply. This is what may be called “overheating.” Also, if too much money is put into the economy too quickly by government policies—money printing or artificially low interest rates—price increases happen.

But when the cost of goods goes higher because of increased costs of production, this is cost-push inflation. A weaker peso and an increase in the price of crude oil have increased the cost of production of everything.

If for whatever reason there is too much money in the economy creating too much demand that cannot quickly be met with increased production, raising interest rates will have the effect of reducing the money supply and lowering demand and prices.

However, “cost-push” inflation has nothing to do with an increase in the amount of money. In this case, an increase in interest rates is not a solution.

The inflation rate accelerated to 6.4 percent in August 2018 over August 2017. In January the rate was 3.4 percent, and in May it went to 4.6 percent. We know that the increase in taxes caused part of the price increases as taxes are part of the production cost of goods. The peso has depreciated about 9 percent, also pushing up production costs and prices.

All these factors pushed the inflation rate. Virtually all goods are substantially higher than at the beginning of the year. But the one “price” increase that you will not read about is the cost of borrowing money from the BSP, which the banks do every day. That borrowing rate which goes through the entire economy is up 30 percent.

The BSP raised its base interest rate in May by 0.25 percent, in June by 0.25 percent and in August by 0.50 percent. We were told that this would help mitigate inflation. It has not. We were told this would keep the peso from devaluing too much. It is has lost 4.5 percent since the first rate hike.

BSP Governor Nestor A. Espenilla Jr. said this week that August’s higher-than-expected inflation rate was “an unfortunate confluence of cost-push factors.” If this is true, why add fuel to the price-increase fire by raising interest rates and the cost of money?

Espenilla: “It is equally apparent that strong domestic demand is making it too convenient for producers and traders to pass on higher costs.” That sounds like an excuse since private consumption spending growth (demand) has increased in 2018 at the lowest rate since 2014.

Espenilla concluded: “These warrant more decisive nonmonetary measures to fully address.” In other words, the monetary policy of raising interest rates has not achieved its goal. Now it is up to the political government to find solutions. We may be in for more economic trouble.




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