Philippines inflation and the economy

In recent months, the country has been experiencing rising prices of goods and services.

Recent inflation. On a year-on-year basis, the inflation rate by end July this year was 6.4 percent. In the prior month of June, it was 6.1 percent. But in May, it was 5.4 percent.

The 2022 annual rates of inflation constitute an acceleration of price increases given that the average annual inflation rates for 2021 was 3.5 percent and 2.4 percent for 2020.

An inflationary spiral is threatening to break out and this constitutes a red flag for public policy intervention.

The maintenance of price stability in the economy is a responsibility of government. In fact, this is the principal responsibility of the Bangko Sentral, which is the country’s monetary authority.

Moderate and serious inflation. The Philippine inflation, at 6.4 year-on-year, is high and unpleasant, but it is within manageable control from a policy viewpoint.

In fact, the Philippine development policy incorporates tolerance for a three  to four  percent annual inflation from the viewpoint of economic development and growth policy. That is built-in within the Bangko Sentral’s acceptance of relative price stability.

Economic growth is essentially a situation when both total demand for spending could be in some form of imbalance with the expansion of output, which in essence is the level of supply. As long as that imbalance is not large, the process of growth and development is sustainable and within a range of relative price stability.

In fact, at less than 10 percent, the measures available for control and moderation could still be manageable. But the economic and political cost of bringing down the inflation rate can be only be attained at a high political high.

In countries that suffer from very serious economic and political trouble, very high inflation rates or even hyper-inflation (that is, inflation at very high annual rates even exceeding 50 percent) obtain.

It is worth noting that the Philippine economy did experience very high inflation in three distinct historical episodes.

Hyperinflation happened during the dying days of the Japanese occupation in 1944-1945. Very high rates of inflation in 1974 (34 percent, during the energy crisis following the Middle East War) and in 1983-1984 (20 to 50 percent, during the balance of payments crisis caused by an international debt crisis and aggravated by a political assassination). Years of trying adjustments were required for the country to come out and emerge from such inflation.

Causes of inflation. The causes of inflation may be explained by the forces of supply and demand at the macro or aggregate level. It is essentially a tug-of-war – a contest – between the forces of aggregate demand represented by total expenditure on goods and services, and the supply of these in the country.

In general, inflation happens because aggregate demand often exceeds the supply of output. Thus, we observe an increase in the general price level.

As an open economy, the overall supply and demand for goods and incomes is affected by economic imbalances that are influenced by trade. Thus, domestic and external – or international – factors are involved.

At times, external factors are dominant in creating price volatilities.  The current episodes – and certainly the episodes of extreme inflation in the country’s history – have been exacerbated by external reasons.

Natural events also cause imbalances in the supply and demand for goods.

The recent Philippine inflationary experience comes from the combination of domestic economic factors and the effects of external economic and political conditions that have happened in succession.

The Philippines, being an exporter of labor to the world, has a positive influx of worker remittances that form part of the nation’s earnings of foreign exchange. Such remittances get credited to the country’s net income from Filipinos working in foreign economies.

This explains why Philippine gross national income (GNI) exceeds the total output of goods and services (GDP). Before the pandemic, the GNI exceeded the country’s GDP by 10 percent, which means that to that extent, earnings from remittances adds value and purchasing power to the economy’s total output.

Managing inflation. Inflationary pressures can be managed from two distinct sides of policy-making: (1) The fiscal and (2) the monetary. However, what often works best is a proper (3) coordination of fiscal and monetary actions that supports the anti-inflationary policy objectives.

Fiscal operations. The government’s budgetary spending undertakes two types of actions with opposite effects on the economy. Spending increases the level of demand because it adds purchasing power to the economy. But taxes reduce the amount of incomes that people and enterprises can budget for their own use.

The government’s priorities in spending are predicated on the basis of programs and projects in the development plan. Government’s strict commitment to these priorities and insistence on a high quality of spending efficiency makes for prudent use of government’s finances. The agencies and sector departments are responsible for the attainment of the programs of development and the improvement of public services.

Luckily, the tax system has only recently undergone a major reform to make it more revenue productive. The tax and investment incentives program have thus been revitalized. In addition, additional revenue-measures to raise tax and revenue capacity are being planned. Such design will further strengthen the anti-inflation efforts while pushing further growth.

The operations of the government’s fiscal branch in relation to the management of the deficit level is critical to inflation control. Of great importance is the application of a sustainable level of financial deficit from year-to-year. The choice of debt planning to finance investment programs and shortfalls in financing is important in controlling the public debt and its evolution over time. The current development plan has ambitious programs to reduce the fiscal deficit from year to year in a six-year plan.

Monetary policy. The central bank or Bangko Sentral has all the tools to influence the level of interest rates, which is the principal tool to control inflation.

Recently, the central bank made a decisive move to raise interest rates by 0.75 percent to respond to the recent moves of the US central bank to raise interest rates. This was an aggressive intervention, to catch up with the recent strong action of the US monetary regulator to manage the American inflation.

(To be continued.)

Source: https://www.philstar.com/business/2022/08/17/2203097/philippines-inflation-and-economy