Can the BSP Still Rely on the Money Multiplier Process?

Cesar  C. Rufino,

Can the BSP Still Rely on the Money Multiplier Process?

Abstract:

In order to operationalize the transmission mechanism of monetary policies, the Bangko Sentral ng Pilipinas (BSP) utilizes monetary aggregates as intermediate targets in meeting desired macroeconomic goals. Through the "money multiplier approach," levels of various monetary aggregates (MI, M2, and M3) consistent with the pre-planned levels of the ultimate target variables such as output (GNP), price level, employment and BOP deficit are set hoping that upon achieving such money targets the final goals will also be met. This procedure has proven to be quite effective in the past and has helped the BSP a lot in influencing the direction of the country's economic activity.

The popularity of the approach is mainly due, not only to its relative simplicity, but also to the immense intuitive appeal it generates. Everybody understands the fact that as the BSP releases reserve money into the banking system, the banks use this money to lend to the private sector. The money lent out eventually goes back to the banks as deposits and are used again by these banks in the course of their lending. The process is repeated a number of times until the amount initially injected into the system increased k-folds (hence multiplied k times, with "k" being a factor known as the "money multiplier") in the form of bank deposits which everybody knows form part of the country's money supply. This process is the rationale behind the multiplier approach mentioned above. At any rate, as the liquidity of the system expands, the economy heats up fueling the much needed growth.