I dreamed a dream: A BSP decoupling from the US Fed funds policy

The Bangko Sentral ng Pilipinas (BSP) paused the reduction of the benchmark rate at 5.75% in the first policy meeting last month. No surprise here, after the US Federal Reserve Board (Fed) paused its Fed Funds rate at 4.50% in January. The slew of monetary easing by the Fed since September 2024 came to a halt. But the growth rate of the Philippine economy slowed down to 5.6%, lower than the rosy average 6% of official and private forecast, and the inflation rate at 2.10%, the expectation was more easing. But the BSP paused the easing trend for fear of reducing the gap between the Fed funds rate and the BSP policy rate which could bring about capital flight from Philippine papers to US Treasuries.

The US Fed entertains more goals in its Fed fund rate decisions than does the BSP. Foremost among US Fed goals is that the US dollar being a global reserve currency, the Fed must maintain an attractive return to its investors in US Treasuries to stem the de-dollarization trend. That is how the USA raises the wherewithal to finance its trade deficit.

The BSP, by contrast, is concerned primarily with price stability and, with that achieved, secondary goals like economic growth and poverty reduction may be entertained. I don’t totally agree with this hierarchy of goals but that is the law. Price stability is the metric for which the BSP governor can be summoned by the Congress to account if inflation meanders too much higher than expectation. On the other hand, if the BSP policy rate violates the acceptable risk premium between itself and the Fed funds rate (5.75% – 4.50%), we risk being placed in the rear-view mirror of arbitrage chasing portfolio investors and disruption in the stock market. Thus, we run the risk of missing our own county-specific targets, say the growth of poverty reduction target, if we slavishly follow the Fed funds rate movement. Our monetary authorities have made the threat of adverse arbitrage response the tail that wags our monetary policy.

It is reassuring though that BSP is aware of the tradeoff of piggybacking our monetary policy to that of the US Fed. This is the subject of the HSBC Global Research report authored by Aris Dacanay and Lenny Jin. It reported that the BSP Governor admitted that the pause in monetary easing was a decision that they took very seriously precisely because it could be easily construed as humoring vulture capital profit over growth of the economy and poverty reduction. That is not a reason to call the BSP Governor to account. But the Governor admitted that it may resume monetary easing when the “clouds of uncertainties clear.” That resumption unfortunately could be a long way off.

With the onset of US President Donald Trump’s second term — which includes the “total reset” waged against the overreach of DEI (diversity, equity, and inclusion) policies of the previous administration, the weaponization of monetary and trade policies as the posture of the MAGA (Make America Great Again) Republicans, the overtures for the US takeover of Gaza, Canada, the Panama Canal, and Greenland, and the resulting retaliation and walk-back frenzy — the world has just stepped into the uncharted territory of the non-ergodic universe where uncertainty is Knightian or Keynesian. In the familiar ergodic universe we have become used to, the states of the world are known or knowable and the governing probability distributions are well-defined though still to be revealed. To say it mildly, the state of the world in 2025 has turned Hobbesian (from Thomas Hobbes’ Leviathan) and our best course of action is to keep our guns loaded and our powder dry. With the deployment of aggressive weaponization of foreign and trade policy echoing the trade war that deepened and prolonged the Great Depression in the early 1930s, we no longer know who our friends and who our enemies are. Canada is rewarded with a warlike 25% tariff for its friendship and lasting loyalty; Australia is being enveloped in the fallout. Kissinger’s oft-repeated quip has now become the norm: “To be an enemy of America is dangerous, to be its friend is fatal!”

Since we opened our capital account in the early 1990s, ostensibly to improve our performance in attracting foreign investment, the Philippines’ monetary arena have become a playground for the disruptive vagaries of arbitrage chasers. Then Prime Minister of Malaysia Mahathir Mohammed declared a war against these speculative vultures in 1998 to the great outcry of arbitrage chasers and their neo-liberal allies (led by George Soros). Mahathir of course pushed the capital control pedal to the metal to frustrate arbitrage chasers. The verdict, so condemnatory of Mahathir in 1998, has slowly heaved in favor of Mahathir over Soros.

In National Bureau of Economic Research (NBER) Working Paper #30944, Paul Bergin and others using data for 45 countries from 1985 to 2019, found that strategic capital account policies (capital controls) combined with reserve accumulation policies associate positively and strongly with growth in real GDP and TFP (total factor productivity). It appears that the presence of tight capital controls results in a one-to-one correspondence between the growth of reserves and the level of net exports which requires the expansion of the traded goods sector and which has a knock-on effect on TFP.

Our own experience with capital account liberalization is that while we attracted a tons of portfolio investment and its disruptive effects, we failed to improve our direct foreign investment share in the ASEAN. Indeed, the Asian Financial Crisis was exacerbated many times in the Philippines by the capital account liberalization as local banks soaked up on dollar borrowings which eventually they could themselves not service and this became a national liability. Their stop-go cyclical nature tended to exacerbate the boom-and-bust trajectory of the pre-2000 Philippine economy.

As observed, the BSP paused the expected easing of monetary policy at 5.75%. Pausing the expansionary policy when the economy is losing growth momentum, and inflation is in some remarkable quietude (2.1% in February) went contrary to market expectation. Together with many observers, I have expected BSP to continue the reduction of the BSP interest rate.

If ever there was a good time to remind ourselves of our monetary independence, this was it. Instead, the BSP bowed to the arc of history, having surrendered our monetary independence to humor the arbitrage chasers. Still, we take comfort in the BSP governor’s intimation that this decision was not taken lightly. As little as this was, it seems a ray of hope. A reason perhaps to dream that the BSP will finally decouple from the Fed on monetary policy.

But rather than quiver in fear, we need to build our own muscles. Others have gone before us to superior results. When economic growth is the performance criterion, the emerging evidence seemed to favor the fixed exchange rate. Frankel et al. (2019) found that growth performance tends to be negatively related to de facto flexible exchange rate regimes and tends to be positively related to either de facto fixed exchange rate or “systematic managed floating” (intermediate exchange rate regime) regimes. This latter supports a perception of “greater price stability” and consequently more stable macro policy under a fixed exchange rate. Herein is the reason why so-called “currency manipulators” seem to exhibit better results than currency neutralizers.

A “currency manipulator” is a pejorative label attached by the US Treasury or State Department to an economy characterized by a persistent trade surplus (especially against the US) atop a refusal to allow the domestic currency to appreciate. As of November 2024, several countries — China, Japan, South Korea, Singapore, Taiwan, Vietnam, and Germany — were in the US Treasury/State Department watchlist of potential currency manipulators. Vietnam was warned by the US State Department of currency manipulation when it refused to let the Vietnamese Dong appreciate despite an emerging trade surplus. If you ask me, those in the currency manipulator fraternity are among the stellar performers in the development arena.

So, is there a BSP decoupling from the US Fed monetary policy in our future? Yes, but only in my dreams despite the sans pareil Lea Salonga song (“I dreamed a dream” from Les Miserables) goes: “But there are dreams that cannot be and there are storms we cannot weather.”

Perhaps so in the ergodic universe we have long been accustomed to, but perhaps not in the emerging non-ergodic universe. After all, who dared dream that Rodrigo Duterte would ever be whisked to The Hague, Netherlands to face the ICC tribunal?

Raul V. Fabella is a retired professor of the UP School of Economics, a member of the National Academy of Science and Technology and an honorary professor of the Asian Institute of Management. He gets his dopamine fix from bicycling and tending flowers with wife Teena.