TAILIEUCHUNG - Divorcing Money from Monetary Policy

An important determinant of consumer spending is access to credit by consumers through various lending institutions. These institutions include banks, credit and employee associations, social security agencies, cooperatives and other non-banks and informal institutions. However, data on consumer or household indebtedness are available only in reports on credit cards and real estate and auto loans extended by banks that are monitored regularly by the Bangko Sentral ng Pilipinas (BSP). All other data are either not easily accessible or not available in organised formats. Hence, the data used in this paper are limited to those found in the reports submitted by. | Todd Keister Antoine Martin and James McAndrews Divorcing Money from Monetary Policy Many central banks operate in a way that creates a tight link between money and monetary policy as the supply of reserves must be set precisely in order to implement the target interest rate. Because reserves play other key roles in the economy this link can generate tensions with central banks other objectives particularly in periods of acute market stress. An alternative approach to monetary policy implementation can eliminate the tension between money and monetary policy by divorcing the quantity of reserves from the interest rate target. By paying interest on reserve balances at its target interest rate a central bank can increase the supply of reserves without driving market interest rates below the target. This floor-system approach allows the central bank to set the supply of reserve balances according to the payment or liquidity needs of financial markets while simultaneously encouraging the efficient allocation of resources. 1. Introduction Monetary policy has traditionally been viewed as the process by which a central bank uses its influence over the supply of money to promote its economic objectives. For example Milton Friedman 1959 p. 24 defined the tools of monetary policy to be those powers that enable the Federal Reserve System to determine the total amount of money in existence or to alter that amount. In fact the very term monetary policy suggests a central bank s policy toward the supply of money or the level of some monetary aggregate. In recent decades however central banks have moved away from a direct focus on measures of the money supply. The primary focus of monetary policy has instead become the value of a short-term interest rate. In the United States for example the Federal Reserve s Federal Open Market Committee FOMC announces a rate that it wishes to prevail in the federal funds market where overnight loans are made among commercial banks. The tools of

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