Philippines cuts interest rates to spur economy

Read this from my twitter feed: Philippines cuts interest rates to spur economy. Made me want to give myself a crash course on monetary policy.

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary policy can either be expansionary, or contractionary, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply.

The article says that last week Thursday (July 9, 2009), the Philippine Central Bank cut interest rates by a quarter percent point: overnight borrowing rate (the interest Central Bank pays to banks when borrowing from them) was cut to 4 percent, while the overnight lending rate (rate that banks pay when borrowing from the central bank) was cut to 6 percent.

From the looks of it, we are undergoing expansionally fiscal policy which is said to traditionally combat unemployment (whereas contractionary combats inflation).

Here are a our current numbers: current inflation rate dropped to 1.5% this June -- the lowest in 22 years. Quarterly figures of the NSO show that the Philippines' unemployment declined to 7.5% in Apr 2009 from 8% in Apr 2008. Our current GDP for 2008 Q4 is P2,126.8B, growing only a meager 0.3 percent.

Interpreting the data we have, inflation rate dropped (that's neither good nor bad) and unemployment rate declined (that's good), however GDP growth fell short of expectations (not good).

So why the decision to cut interest rates if unemployment is not our problem? It's rather a special case that our GDP is down while our umemployment rate is also down. They are hoping to spur the GDP growth by this. Since the economic growth is measured by GDP, slowing down of GDP growth indicates that the economy is slowing down. In such a situations, monetary policy is used to change the scenario. In our current situation, government decreased the interst rates so that people will spend on products and thus velocity of money supply will ramp up. Banks will be able to lend more to people, people can then use that money for new projects, new projects will cause new jobs and GDP growth (and so forth the multiplier effect).