Prepared by Yoga Affandi and Shanaka J. Peiris.
For simplicity, this paper associates the deposit rate with the interest rate channel and lending rate with the credit channel of monetary policy as in most dynamic stochastic general equilibrium models with a banking sector.
See Chapter 3, Regional Economic Outlook: Asia and Pacific, October 2011 for the historical relationship between rapid credit growth and economic crises in Asia including the role of interest rates in driving the credit cycle.
Following Panigirtzoglou and others, 2000, the divergence (d): market interest rate - policy rates is modeled as:
Fermo (BSP, 2009) also recognized this deviation, saying, “there appears to be some divergence between the two rates, as the global financial crisis has weakened to a certain extent the traditional transmission mechanism of the interest rate channel to the real economy.”.
The impact on deposit rates shows a similar pattern but this paper focuses solely on the transmission to lending rates given the greater importance of the credit channel of monetary policy in the Philippines (see IMF, 2011).
Also, the impact of policy rates on the lending rate is similar to its impact on the T-bill rates, indicating that policy rates influence lending rates to the extent that it affects the T-bill rate.
Thus, the following sections focus exclusively on the spread between the T-bill rate and policy rate.
Although the BSP has the legal authority to issue its own bills in the current BSP charter, it is highly constrained by the clause: “provided that issuance of such certificates of indebtedness can be made only in cases of extraordinary movement in price levels.” A bill currently being considered within Congress would have the effect of deleting this clause.
SDAs were introduced in November 1998 to widen the BSP’s toolkit for liquidity management.
Global interest rates are often viewed as a key driver of long-term bond yields in emerging Asia. See, for example, Regional Economic Outlook: Asia and Pacific, April 2011, Chapter 1.
The ordering of the VAR is: U.S. T-Bond, portfolio flows, government bond issuances, excess reserves (SDA+RRP), and the spread (91-day T-Bill-RRP).