Inflation and Economic Growth in the Philippines

1 For comments, suggestions or further inquiries please contact:Philippine Institute for Development StudiesThe PIDS Discussion Paper Seriesconstitutes studies that are preliminary andsubject to further revisions. They are be-ing circulated in a limited number of cop-ies only for purposes of soliciting com-ments and suggestions for further refine-ments. The studies under the Series areunedited and views and opinions expressedare those of the author(s) and do not neces-sarily reflect those of the for quotation without permissionfrom the author(s) and the Research Information Staff, Philippine Institute for Development Studies3rd Floor, NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, Makati City, PhilippinesTel Nos: 8924059 and 8935705; Fax No: 8939589; E-mail: visit our website at 1996 Inflation and Economic Growthin the PhilippinesDISCUSSION PAPER SERIES NO. 96-11 Josef T. YapINFLATIONANDECONOMICGROWTHINTHEPHILIP PINES'Jo_' "Inflationisdead" , ,1992-95,inflationreacheddoubledigitleve lsinthepastninemonths,averaging11percent overthisperiod(seeTable1).

2 "fundamentalproblemofreconcilingpolicies foreconomicgrowthanddevelopmentwithpolic iesformoderatinginflation." "TheFundamentalProblemofReconcilingPolic iesforEconomicGrowthandDevelopmentwithPo liciesforModeratingInflation" ,NewDelhi, ,PhilippineInstituteforDevelopmentStudie s(PIDS). "Washingtonconsensus,"atermcoinedafterth eworld' , "Washingtonconsensus"isfreemarketsandits concomitantprogramsofliberalization, "Washingtonconsensus,"Krugman(1995)state sthatestimatesofthecostofinflation--defi nedastheoverallreductioninrealincome--ar e"solowthattheyareembarrassing."Heisquic ktoadd,however, , , , (1982,1983),Naish(1986),Dmaziger(1988)an dBenabouandKonieezny(1994).Inflationaffe ctsoutputwhenfirmshavetoincurcostsasthey adjusttothenewpricelevel( ).Atthemacroeconomiclevel, (1993). (ReyesandYap,1993a),forexample, , , (1996)hasasimilarinvestmentequation, (LCPI)tobepositivelyrelatedtothemovingav erage3ofmoneysupply(LMAMS),amovingaverag eofwages(LMAW),amovingaverageofthepriceo fimportedinputs(LMAPM),andthepastlevelof CPI(LCPI[-I]).

3 (TBCPI)and,rathersurprisingly,totherateo fcapacityutilization(CAPU).Inequationfor mwehave++++-LCPI--f(LMAMS,LMAW,LMAPM,LCP I[-1],TBCPI,CAPU)(1)Thesecondequationsho wsthewagerateasproxiedbythecompensationo fnon-agricultureworkers(LNQSE,whichisaco mponentofWinequation[1])tobenegativelyre latedtotheunemploymentrate(UNEMPR)andpos itivelyrelatedtoamovingaverageoftherateo fcapacityutilization(MACAPU)andthepastle velofinflationwhichcapturesindexation(LC PI[-1]).Inequationformwehave-++LNQSE=f(U NEMPR,MACAPU,LCPI[-1])(2)Meanwhile,theun employmentrateisfoundtobenegativelyrelat edtoamovingaverageofthecapacityutilizati onrateandthelaggedunemploymentrate,thus: +UNEMPR=f(MACAPU,UNEMPR[-1])(3)Finally,w ehavetheinvestmemequationwherethelogarit lm_ofgrossdomesticcapitalformation(LGDCF ) :LGDCF=f(LNMAGDP,INFL)(4) , (i)isduetosimultaneity,andisareflectiono ftherelationshipbetweeninflationandinves tmentinequation(4).Notethatinvestmentand capacityutilizationaredirectlyrelate&Ing eneral,whenthedirectionofflowisfromhighe rgrowth(originatingfromthesupplyside), (4) (g)oninflation(INFL)overtheperiod1970-19 95yields:g= +.

4 572g,( )( ) 'eyLMtest(4lags):N*R2= ,weestimateamodelsimilartotheonedevelope dbyRobertLucasandRobertBarroandappliedby Hanson(1980). (whichmeansthatmoneysupplygrowthremainsu nchanged) , (1996) , (1996),usingamonthlyinflationmodel,hassi milarfindings."I'hepriceindexforimportso fnon-fuelshasthehighestelasticity, (1985).Inthelatterstudy,thevariableswith thelargestelasticitiesaretheliquidityvar iable, ,however, , (1983) , (1991).Byestimatingamacroeconomicvectora utoregressionmodel(VAR)andapplyingvarian cedecomposition, ,however,thatthefiscalviewofinflation,wh ichcontendsthatthemaindeterminantismoney supplygrowthfuelledbyfscaldeficits, (1987) "thesimplequantitytheorjyofmoneyisoversi mplifiedandhidesthefu!limpactofmonetaris tprescriptionstoinflationandthatitneglec tsthetransmissionmechanismofcreditmadmon etarycutbackwhichmayentailadrasticfallin income,investments,personalconsumptionex penditureandmostlikely,governmentspendin g." , :StabilizationandOutputGrowthTheeconomic structureofthePhilippineshaschangedveryl ittleoverthepasttwoandahalfdecadesandpor traysmuchofaLatinAmericanprototypeeconom y:adualisticstructureinwhichasmallpropor tionofthelaborforceisemployedinacapital- intensiveandhighlyprotectedmanufacturing sector, , (1996).

5 ,consistentwiththeeconometricevidence, ,aspilloveroftheimportsubstitutionprogra minthe1950s, ,economicperformanceinthe1970scanbemeani ngfullydividedintotwosub- (Consolidationphase) , (amajordevaluationandthefirstoilpricesho ck).1975-79(Periodofdebt-ledgrowth)Thisp eriodbeginswithadjustmenttothefirstoilpr iceshockandfallingpricesofmajorPhilippin eexportcommodities, 'sexceptionalgrowthisalsofuelledbyanexpo rt-orientedprogram, (theWorldBank,inparticular), :forinstance,exportsofsemi-conductorscon tributemorethan10percentoftotalexportear nings, ,backwa::dlinkageswiththerestoftheeconom yaresmall, ,thoughbelowtheperfornaanceoftheeconomy, isnotunsatisfactorycomparedwiththeperfom aanceofthesectorinneighboringcountries, (fertilizers,creditsandhigh-yieldingseed s)inanumberofimportantsubsectors(especia llyrice) ,effectiveimportsubstitutionand,inpart, $336in1974toUS$586in1979; ,relativeprices(internaltermsoftrade)app earfavorableatthestartoftheperiod, , ,decliningrealwages,andemploymentgrowtht hlli_gbehindoutputgrowth(particularlyini ndustry) , :1980-82,1983-85, (Pre-crisisstage)This"pre-crisis' ,inseque_ce,thesecondoilpriceshock,thest eepincreaseinworldinterestrates,recessio nintheindustrializedcountries,andanaddit ional(short-term) , 'sattempttoselectivelybailoutfavored.

6 (Crisisstage)Amajorbalanceofpaymentscris isemergesastermsoftradecontinuetofalland availableexternalfinancecontracts, ,cutsinpublicexpenditure, (M3) " ,exacerbatedbyahighinterestratepolicywhi chattemptstoarrestprivatecapitaloutflows ('capitalflight') , ,asitdeclinesfromUS$723in1982toUS$ ,however, ,mainlyexpenditure-reducingdomesticadjus tment, ,alongwithcontractionaryfiscalandmonetar ypolicies,resultinadepreciationofthereal effectiveexchangerate(REER), ,alongwiththeseverecutsinimports, ,thecrisishastensthecollapseofthepolitic alregime,asalleconomicsectorsareaffected andthedomesticcoalitionsupportingtheMarc osregimeseesitsfinancialresources(domest icandforeign) (PeriodofDifficultRecovery)Thisperiodsta rtsoffwiththeinternalshockofthecollapseo ftheMarcosregimeandtheinstallationofanew governmentembarkingonaprogramo ,whiledebtreschedulingandnewsourcesofext ernalfunding(officialbilateralandmultila teralflows) ,recoveryofcoconutprices, , , $ , $700in1989, (RecessionandFiscalConstrain0 Anotherbalaneofpaymentscrisisensuestowar dsthelatterpartof1990, ,butthisdoesnotmaterializebecauseofaseve reenergycrisisthatcanbetracedtoafiscalco nstraintwithpublicinvestmentininfrastruc turecutbacktowellbelowtwopercentofG?)

7 , , , , , ,where80percentofindustrialoutputisprodu ced, ,whichhasnotbeenasforthcomingasexpected, ( , , , , , ';onproudlyannouncesthatpercapitaGNPsurp arsesthe$1,000tlu'esholdin1995, , , (_Pcrisesensue, , ,theexc"hangeratehasbeenaprimarytargetof monetarypolicyasshownbyGochoco(1992).Byc omparingthevolatilitiesofmoneyaggregates andtheexchangerate, ,ReyesandYap(1993b) , :er1985istheinternaltransferproblemwhere inthegovernmentowesthebulkoftheexternald ebt(about80percent) ,ofcourse, (Medalla, ).Thiscanbealsobeobservedbycomparingthem ovementintheREER ofthePhilippineswithothercountriesinther egion,someofwhichareourclosestcompetitor s(Table4). , , :"Thecontinuingshiftinrelativepricesthat makesrealestate,financialspeculationandr etailtrade(economicactivityinnewshopping malls)attractivevis-_-vistheindustrialan dtradeablesectorsisadisturbingtrend."Ano thereffectnfanovervaluedcurrencyisawiden ingtradedeficit(TableI),whichreached12pe rcentini994and1995, 'spropensitytoimporthasbeenincreasing(Ta ble6) , (withtherequiredbackwardlinkages) (torestraininflation,ofcourse)wasmademor edifficultbecausetotalnationalgovernment expendituresbegantoincrease, ,thisitempeakedat35percentin1988beforese ttlingat31percentin1991(Table7).))

8 Whiletheyieldandelasticityoftaxrevenuesi ncreased, ,MaintefianceandOperatingexpenditures(MO E) ,publicinvestmentonapercapitabasisdeclin edbyalmost50percentbetween1981and1991(Ta ble8).Meanwhile, , (1995) ,thedeficiencyinin' (1987).Asidefromtheirinflationaryimpact, , ,periodsoflowmoneygrowthareassociatedwit hlowGDPgrowthandrelativelyhighinflation( Table1), ,Krugman' , "honorflaydebt"commandmentinplace,moneta ry, , ,economicmanagershavetocontendwithvolati lecapitalflowsandasaresult, ,ithasbeenproposedthatinsteadoftargeting monetaryag_regates,theCentralBanktargets interestratesandanappropriaterealexchang erate(DeDios,1995).Nevertheless, , , (1991),"SourcesandVariabilityofInflation inanOpenEconomy." , (1983),"DeterminantsofInflationinthePhil ippines." , (1994),"OnInflationandOutputwithCostlyPr iceChanges:ASimpleUnifyingResult,"Americ anEconomicReview84(1), ,L.(1988),"CostsofPriceAdjustmentandtheW elfareEconomicsofInflationandDisinflatio n,"AmericanEconomicReview78(4), , (1995),"OnRecentFinancialFlows:Causesand Consequences"inFabellaandSakai(eds.)

9 Fabella, ,eds.(1995) ,S.(1993),"MacroeconomicFactorsinGrowth. "PaperpresentedattheWorldBankConferenceo n"HowdoNationalPoliciesAffectLong-runGro wth?".Gochoco, (1992),"Targets,Instruments,andMonetaryP olicyinanOpenEconomy:AGARCHA pplication." , , (1980),"TheShort-RunRelationBetweenGrowt handInflationinLatinAmerica:AQuasi-Ratio nalorConsistentExpectationsApproach"Amer icanEconomicReview,70(5), ,P.(1995),"DutchTulipsandEmergingMarkets " ,74(4), , (1987),"TheNewStructuralistCritiqueofthe MonetaristTheoryofInfl_ion:TheCaseoftheP hilippines," , (1995),"StructuralShiftsinKeyMacroParame ters:ImplicationsontheSustainabilityofGr owth"inFabellaandSakai(eds.).14 Lim, (1996),"OntheQuestionofaTradeoffBetweenS ustainableGrowthandPriceStability" , (1985), , , , , (1995),CatchingUpwithAsia' , (1996),"MacroeconomicVolatility,Investme ntAnemiaandEnvironmentalStrugglesinthePh ilippines,"WorldDevelopment,25(2).Naish, (1986)"PriceAdjustmentCostsandtheOutput- InflationTrade-off,"Economica53(210), , (1996),"AnEmpiricalAnalysisoftheDetemlin antsofInflationinthePhilippines" , (1993a),"Re-estimationofthePIDSM acroeconometricModel" , (1993b),"MoneyandPricesinthePhilippines, 1981-1992:ACointegrationAnalysis,"Journa lofPhilippineDevelopment,VolumeXX, ,J.

10 (1982),"MonopolisticPriceAdjustmentandAg gregateOutput,"ReviewofEcononzicStudies, 49(October).Rotemberg,J.(1983),"Aggregat eConsequencesofFixedCostsofPriceAdjustme nt,"AmericanEconomicReview73(3), , (1996)ThePhilippineEconomy:EastAsia'sStr ayCat?--Structure, imiIiiii,iYearInflationGDPM oneyExchangeTrade91-dayExternal(%) Growth supplyRateBalance/T-billDebtrategrowth(P /S)GDP(%)(mUS$)(%)(%)(%)IIIIIIIIIIIIII19 7015, , ,95239319728, , , , , , , , , , :PhilippineStatisticalYearbook, ,1970-199516 Indicator1970-741975-791980-821983-85198 6-891990-921993-95 IIIIII" ';aRe_!Income,pesos98311158912669_"32810 8711146111525 RealGNP(% Growth ) , , , , (%sharetoGNP), ,0917,0318, , ,97 RealGDP(%shares)Agriculture27, ,922_622_2 Industry35, , , (%ofGNP) ,045,354,1 CurrentBalance/GNP(%) ' ,1-0, (%)1, (index)_b97, (index)_c98, (%) , (M3)(growthrate)19, , ,515,025_5 GrossInternationalReserves,mS74317672480 937220738946814V,LaborSectorOpenUnemploy mentRate(%) ,18,911_210,48,66_6 UnderemploymentRate(%) , ,5 RealWageIndex(unskilledurban) (%shares) (%)\ , (growthrate)17,410, (growthrate)25,78, (%change) ,122,3 VIIP opulation(rail,,endofperiod) (%) ,44460,46800,4507No,offamiliesbelowpover ythreshold(m) , ,559 IXGNP percapita(US$,endofperiod)3365567235_.