IT is taught in any basic macroeconomics course that monetary policy is not the best tool for a supply-side problem because it is a demand-side tool that influences spending, borrowing costs, and aggregate demand rather than the actual capacity or physical production of goods and services. To put it more sharply, lower interest rates do not directly create physical commodities like oil or rice.
Although it is true that monetary policy cannot fix supply-side issues directly, the Bangko Sentral ng Pilipinas (BSP) has tightened due to severe risks that have cascaded beyond the initial supply shocks-Middle East tensions driving up global oil prices and El Niño hitting agriculture. Its surprise 50-basis-point rate hike, which came amid accelerating inflation, a weak peso, elevated global energy prices, and the risk of weather-related food shortages, is justified primarily as an attempt to prevent an inflation shock from becoming entrenched, rather than as a way to bring inflation down immediately. The key question is not simply whether inflation is high. It is whether the expected cost of allowing inflation to spread will outweigh the damage that tighter monetary policy could inflict on a weakening economy. Three critical reasons are worth considering.
One, the BSP is deeply concerned about second-round effects-when high costs mutate into broader, demand-driven inflation. Higher food and fuel prices could lead to demands for higher wages and increased transport fares. Once businesses raise prices generally to cover these wages and transport costs, inflation becomes structural and persistent. The BSP hikes rates to cool down aggregate demand so that it becomes harder for businesses to pass on costs to consumers.
Two, the Philippine peso has faced severe downward pressure. It has recently plummeted to record lows. Because the Philippines imports vital commodities like crude oil and rice, a weak currency makes those items significantly more expensive in local terms. Thus, higher Philippine interest rates may support the peso by improving the relative attractiveness of peso-denominated assets, although exchange rates also depend on global risk appetite,
capital flows, and expectations. The BSP, therefore, has a legitimate reason to consider currency depreciation in its inflation outlook.
Three, when headline inflation jumps sharply, the public begins to expect high inflation as the new permanent normal. September headline inflation rose to 7.2 percent, from 6.1 percent in August, while core inflation climbed to 4.7 percent. The increase in core inflation matters because it suggests that price pressures may be spreading beyond volatile food and energy prices. If consumers expect things to cost 7 percent more next year, they demand higher pay and buy goods immediately. Again, this creates a self-fulfilling inflationary spiral.
Indeed, monetary policy is a game of brutal trade-offs. True to its mandate of maintaining price stability, the BSP has made the right structural decision to fight inflation, but it comes with severe economic consequences. For households, higher borrowing costs on loans and mortgages, alongside already elevated food and transport expenses, could squeeze disposable income. For businesses, more expensive credit discourages investment, expansion, and hiring, especially among smaller firms. For broader economic growth, weaker consumption and investment could deepen the slowdown and reduce employment opportunities. For government finances, higher interest rates can increase the cost of new borrowing and refinancing, depending on debt maturity and market conditions. For inflation itself, monetary tightening works with a lag. It will not immediately reverse higher oil prices or repair weather-damaged food supplies.
One can argue that it is easier to recover lost growth momentum. In other words, a stalled economy can be stimulated back to growth relatively quickly with standard monetary tools. However, once inflation expectations run wild, it will be an agonizing multi-year process to tame them.
A high-inflation environment will not be conducive to growth for several reasons. One, when prices fluctuate wildly, businesses cannot forecast costs, calculate margins, or safely plan long-term capital investments. They pull back and go into survival mode. Two, high inflation acts as a hidden tax on savings. Domestic and foreign investors pull their money out of the financial system and move it to stable foreign currencies. This would starve the domestic economy of investment capital. Three, instead of investing in productive, growth-inducing enterprises, capital flees into speculative hedges, such as gold, real estate, or foreign cash, just to survive.
So, the BSP has drawn a line in the sand. It signals to the entire economy that it will stand as the anchor of stability, even if it means a temporary contraction. The goal is to protect the structural foundations of the economy so that when growth does recover, it will be built on solid bedrock, not shifting sand.
Dr. Ser Percival K. Peña-Reyes teaches economics at the Ateneo de Manila University. He is also a Senior Research Fellow at the Ateneo Center for Economic Research and Development.