Pandemic management: Should the monetary authority do the heavy lifting?

Five lessons of previous financial crises have helped the BSP navigate treacherous pandemic waters. First, price stability should anchor monetary policy. Second, central bank independence should be maintained. Third, central banking is best complemented by fiscal measures and structural reforms. Fourth, central bank support has moral hazard risks especially when bailouts are involved. And finally, policy should consider unintended consequences to the general economy.

More than a decade ago, after the Global Financial Crisis and the dislocation of some European and Asian debt markets, monetary policy and banking regulations helped mitigate impaired money, securities, and foreign exchange markets.

During Alan Greenspan’s first year as Chairman of the US Federal Reserve Board, he was baptized in the October 1987 stock market crash. A good way they dealt with the crisis was to operate outside the box. While providing liquidity to the market, the US Fed, through Fed New York President Gerry Corrigan, also talked it up.

Greenspan paraphrased Corrigan’s line thus: “We’re not telling you to lend; all we ask is that you consider the overall interests of your business. Just remember that people have long memories, and if you shut off credit to a customer just because you’re a little nervous about him, but with no concrete reason, he’s going to remember that.”

But of course, in his book The Age of Turbulence: Adventures in a New World, Greenspan quipped “I’m sure he bit off a few earlobes.”

By the first two quarters of the following year, the US economy showed signs of robust growth. The Dow Jones was stabilized. The US economy’s resilience held sway. People believed in the solid narrative and the long period of US economic growth was ushered in.

Earlier, to secure his Congressional initial confirmation in July 1987, Greenspan committed to adopt a monetary stance necessitated by economic and financial market conditions. He assured that policy would be driven by economics rather than by politics. Central bank independence was to be a mantra of the Greenspan years. Greenspan also asserted that the primary focus of central banks was on managing inflation because failure to do this would leave very little opportunity for sustained economic growth.

Former Bank of England (BoE) Governor Mervyn King also endorsed this focus, cautioning central bankers to avoid getting into issues concerning resource allocation. He suggested that central banks must guide the economy by sending the market appropriate price signals. King also espoused humility and acknowledged central bank limitations, by confessing that “we have not targeted those things which we ought to have targeted and we have targeted those things which we ought not to have targeted…”

During this pandemic, there are signs that central banks, especially in emerging markets, are again tasked with the heavy lifting to support financial markets and economies.

While central banks ensure liquidity and credit, it is crucial that their independence and solvency are safeguarded. This is done by sharing risks with fiscal authorities. Should central banks engage in riskier arrangements like purchases of private mortgage-backed securities, direct support of the government should be available.

Moreover, monetary assistance should be clearly communicated to the markets for transparency. Markets are assured by this and derive confidence from their regulators’ awareness of pandemic dynamics and its implications on economic growth. This is critical to maintain public trust in reviving the economy.

What are signs of central banks’ heavy lifting?

The IMF recently released a compendium of how 17 central banks from advanced economies, 55 from 81 emerging markets, and 31 from 49 low income countries, have supported financial markets during this pandemic.

Central bank interventions mainly addressed both loss of funding and market liquidity. The IMF documented markets for intervention; the trigger mechanisms; risks addressed; and collaterals involved. Monetary operations range from price to longer-dated operations and quantity programs. Heavy lifting is most evident in lowered policy rates to infuse liquidity into markets, and to ease strains on short- and long-term funding markets as well as in securities and FX markets.

What about the Philippines? In a June 2020 Bangko Sentral ng Pilipinas (BSP) working paper, “Shifting Macroeconomic Landscape and the Limits of the

BSP’s Pandemic Response,” economists Eloisa T. Glindro, Hazel C.Parcon-Santos, Faith Christian Q. Cacnio, and Maritess B. Oliva documented pandemic responses of the BSP.

The BSP is clearly aware of the lessons of previous financial crises and of IMF and World Bank guidelines as suggested by standard setting bodies such as the Basel Committee on Banking Supervision, the Financial Stability Board, and the International Financial Reporting Standards Foundation.

Five lessons of previous financial crises have helped the BSP navigate treacherous pandemic waters. First, price stability should anchor monetary policy. Second, central bank independence should be maintained. Third, central banking is best complemented by fiscal measures and structural reforms. Fourth, central bank support has moral hazard risks especially when bailouts are involved. And finally, policy should consider unintended consequences to the general economy.

Also considered were principles from international financial institutions on, among others, the use of embedded flexibilities in the regulatory and supervisory framework; on well-designed public and private support interventions focusing on affected borrowers; and on ensuring that moral hazard is minimized.

The BSP’s current responses cannot be described as nominal or light. Its 175-bps cumulative policy rate cut is estimated to expand domestic liquidity by more than P46 billion in the next 12 months or around 0.2% of GDP. The BSP also granted provisional advances to the National Government amounting to P300 billion or 1.6% of GDP. As part of its open market operations, it also purchased government securities of nearly P68 billion or 0.4% of GDP.

Other liquidity-enhancing measures include the 200-bps drop in the RRR. This translates into P200 billion in additional money supply or around 1% of GDP. It also halted mopping operation through the term deposit facility, releasing about P300 billion or another 1.6% of GDP. With the reduction in the overnight reverse repurchase volume starting April 2020, some P200 billion was freed into the system, an equivalent of 1.1% of GDP.

The BSP also tweaked regulations to: one, incentivize lending to specific sectors particularly MSMEs; two, extend financial relief to borrowers; three, temporarily relax prudential accounting measures; and four, facilitate continued public access to financial services.

That the BSP is able to support the national effort against the pandemic’s debilitating economic impact, evidences the existence of monetary space. This is a privilege that should not be lost on the BSP as decades of central bankers were baptized in fire to help achieve this.

Governor Gregorio Licaros had to ask, hat in hand, our New York creditors to continue lending to the Philippines. Governor Jaime Laya dealt with the debt moratorium. Governor Jose Fernandez restructured our external debt. Governor Jose Cuisia sorted out FX regulations given scarce FX. Governor Gabriel Singson brought the country to a safe harbor during the Asian Financial Crisis. Governor Rafael Buenaventura further cleaned up the banks and secured the initial anti-money laundering law. Governor Amando Tetangco was successful in navigating the Global Financial Crisis. Governor Nestor Espenilla advanced his advocacy for financial inclusion and banks’ adherence to international best practices. And Governor Benjamin Diokno now has this pandemic in his hands. A book is worth writing on the details of these experiences, all telling.

The BSP celebrates its 27th founding anniversary today with the tagline, “Bayanihan Para sa Bayan.” It has clearly done more than enough in working towards economic bounce back.

Looking to the future, the BSP men and women should always remember that economic resilience triggers a very positive feedback loop. The Philippines’ 21 years of uninterrupted economic growth show its resilience to shocks. Deregulation in key sectors including power, water, and oil industries has reaped good economic and financial returns. Market confidence can be leveraged on to keep business and new investments hopeful and trusting.

Finally, accountability, transparency and communication are essential as these principles are always superior to fixed rules. While the quintessential central banker Paul Volcker would advise central bankers to keep the “mystique,” Ben Bernanke would always advocate transparency. “Transparency about the Fed and our policies …was proving essential for the greater battle of winning the public’s trust.”

The BSP should know its bias.

DIWA C. GUINIGUNDO is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 20012003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.