Understanding Inflation'S Dangers To Philippine Economy

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Throughout the most parts of the world, consistent efforts are placed to reduce skyrocketing inflation rates to fall on targeted bands of an economy. Motivated by the convention that inflation bring harmful effects. In the Philippines’ inflation rate soared up to 6.7% for months September and October in 2018. It was dubbed as the “inflation hysteria of 2018” reported to be the highest in the course of 9 years derived from the data published by the Philippine Statistics Authority (Bueza, 2018) This paper aims to provide a clearer understanding with inflation, present the concept of moderate inflation, and discuss the idea of negative inflation as inauspicious to an economy. Achieved through gathered historical accounts that illustrates the effects of deflation. Afterwards relate this event to the context of the Philippines. As the local economy cools inflation below its target inflation, it is expected to yield both good and bad implications. Derived from the history showed the country and other countries and some theorized expectations in such an event the country is under such condition. To have a better understanding in the discussion let us define some crucial terms that will be thoroughly tackled in the later discussion. Inflation it is the rate of increase in the general level prices of goods and services. The time where inflation rate is rising steeply the citizens have a challenging time pacing with the level of fast increases in prices matched with the same level of income. Many are forced to buy less goods or find a cheaper substitute to sustain one’s well-being with lower living standards. Furthermore, volatile fluctuations of inflation rate present great risk of uncertainty for investors leading them to refuse investing in the country. That is why economies executes policies to control inflation rates to prevent them from sharply rising. This would avoid the economy from overheating where prices are soaring high because of the inability of that might lead to the crash of the economy. In addition to this, lowering of general prices certainly appear attractive to everyone. Taking these into account, would things we better without inflation, where prices remain the same or even reduce across time. Going below inflation rate is called negative inflation such as deflation. In Japan after its financial liberalization in 1980s which have Japanese banks exposed to tougher competition and entered into riskier transactions, lending huge amounts to property developers and raising funds on the stock market.

This resulted in a rise of equity and real estate prices that, along low interest rates, eased the cost of investment. Consequently, the ratio of bank loans to GDP rose. Credit backed by property fueled economic activity and real GDP grew at an annual average of 5 percent during 1985-1990. As asset prices continue to rise, the Bank of Japan decided to increase interest rates in 1989 to halt the economy’s overheating. The result was immediate: the stock market collapsed at the beginning of 1990 and GDP growth declined from a peak of 5.5 percent in 1990 to 2.5 percent in 1991. As land prices were still increasing, the BOJ continued to increase interest rates until GDP plunged, land prices declined, and inflation started to fall. The resulting decline in asset prices disrupted the smooth functioning of the financial system. Borrowers who used land as collateral found the value of their collateral diminished. Banks seeing the increased possibility of losses from loan defaults, started to restrict credit, making it more difficult for borrowers to service their debts. Borrowers began to default and banks were soon over- whelmed by bad debts, forcing them to reduce lending further. The decline in stock prices also reduced bank capital. Companies faced with massive debt and excess capacity slashed their investment and production, and households reduced consumption to save more for difficult days ahead, with the weak demand leading to further price declines. (Ahearne, Gagnon, Haltmaier, & Kamin, 2002). While low inflation is a desirable feature of the economy, there are several reasons why the continuous negative inflation (i.e., deflation) can be a cause of concern to policymakers.

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The most commonly heard argument is that consumers and businesses could delay spending and investment if they expect that prices will be lower in the future. Lower demand, in turn, could lead to slower growth, higher unemployment and further price declines. Japan provides an evidence to this argument. During its “lost decade” (i.e., 1991 – 2000), Japan experienced deflationary pressures that led to lower household consumption through delayed purchases, mainly of durable goods (Hori & Kawagoe, 2011) Inflation and deflation are two sides of the coin that equally pose challenges to the conduct of monetary policy. While high inflation is undesirable, deflation is likewise unfavorable for the economy. High inflation has been the more common experience across regions but global developments in recent years have caused deflationary pressures to become prominent in some economies. For the Philippines, inflation has remained relatively low, but the threat of deflation is not apparent. Nonetheless, going forward, the BSP maintains its commitment to ensure that inflation is neither too high nor too low but just right to support the attainment of a balanced, sustainable and inclusive growth.(Cacnio, 2017) Deflation can be benign and accompanied by strong economic growth. It can also lead to a downward spiral in output, employment, and demand, in a context where normal policy options cannot be affected. This is particularly true when debt levels are already high. Consequently, the best policy is to preempt deflation. When it is too late to prevent deflation, aggressive monetary easing through innovative methods may become necessary. While the dangers of deflation are not severe at present, a watchful policy stance is advisable.(Brooks & Quising, 2002) Moderate inflation rate is 2-4 percent as claimed by economists. In the Philippines BSP’s target inflation rate is same as this ideal inflation rate band. This band is seen to let the economy grow. Inflation and economic growth other countries and the Philippines.

Resurreccion (2014) examined inflation, unemployment and economic growth of Philippines in accordance with Okun’s Law and Phillips Curve by applying unit root test, OLS regression technique, White’s test and VIF during 1980-2009 and found that unemployment is inversely related to economic growth and inflation, confirming Phillips Curve and Okun’s Law in the Philippines for the analyzed period. analyzed inflation dynamics in short run of Philippines in accordance with Keynesian Phillips curve by using Cobb-Douglas model during 1988-2009 and found that sensitivity of inflation is a declining one because of the flattening Phillips Curve in Philippines for the analyzed period (Cacnio, 2013). Tested inflation and unemployment of Philippines in accordance with Phillips curve by applying regression analysis during 1981-2002 and found that there is a tradeoff between unemployment and inflation for the Philippines for the analyzed period. (Bagsic, 2004) Positive association between inflation and unemployment is a unique challenge for the policy makers. When unemployment decreases, discretionary income rises, demand rises and consequently price increases.

On the other hand, when unemployment is high, demand falls and consequently price decreases. During this stagflation period (1950-2017) in Philippines, as it hinders economic growth, currency of Philippines should be removed from gold standard and should left for floatation. Production costs could be cut down to eradicate job lose. Interest rates could be increased to reduce inflation rate. GDP should be forced to regain the job lost. However, if inflation rate and unemployment rate both are low, it could be good for the economy while low unemployment rate can trigger global demand of goods which could maintain a lower inflation rate. There is a positive relationship between inflation and annual wage rate but wage growth in relation to inflation is low, which may cause low productivity or per hour output. In such situation, labor productivity or per hour output should be increased to grow the average yearly wage. There exists a negative relationship between inflation rate and GDP, which is consistent with Phillips curve, may be due to real exchange rate movements, tax, government spending, money growth and oil price etc. (Berument, Inamlik, & Olgun, 2008) (Kreishan, 2011) In this paper, the authors used cointegration and error correction models to empirically examine long-run and short-run dynamics of the inflation-economic growth relationship for four South Asian countries using annual data. The main goal was to examine whether a relationship exists between economic growth and inflation and, if so, its nature. In addition to significant feedbacks between inflation and economic growth, the authors found two interesting results. First, inflation and economic growth are positively related. Second, the sensitivity of inflation to changes in growth rates is larger than that of growth to changes in inflation rates. These findings have important policy implications. Contrary to the policy advice of the international lending agencies, attempts to reduce inflation to a very low level (or zero) are likely to adversely affect economic growth. However, attempts to achieve faster economic growth may overheat the economy to the extent that the inflation rate becomes unstable. Thus, these economies are on a knife-edge. The challenge for them is to find a growth rate which is consistent with a stable inflation rate, rather than beat inflation first to take them to a path of faster economic growth. They need inflation for growth, but too fast a growth rate may accelerate the inflation rate and take them downhill as found by Bruno and Easterly (1998). (Mallik & Chowdhury, 2001) (Bruno & Easterly, 1995)

Unemployment Rate, Annual Wage Rate and the GDP of the Philippines

To implement the policy tools in such a way that GDP and annual wage rate positively influence the unemployment rate and inflation rate of Philippines, the government of Philippines should focus on the salient issues like, leadership styles applied in Philippines’ business sector, extroversion and internationalization of local SMEs in export marketable goods, bilateral agreements among local companies of public or private interest, as well as among multi-national parties and businesses’ along with governmental strategic plans undertaken to support the prosperity of local business and family income. This paper might contribute to resolve the problem of stagflation experienced from high level of inflation and unemployment in the economy not only in Philippines but also in the rest of the world. In the long run there might not be any off set between inflation and unemployment rate. In such situation central banks must not fix unemployment rate below natural rate. The novelty of this research is that unlike the earlier studies, annual wage rate has been considered to justify the Phillips curve as well as GDP as the threshold variable. The methodology is also unique in terms of CUSUM and CUSUMQ tests as the stability tests for the model.

In conclusion, the Philippines in the face of deflationary pressures was able to withstand these events but continue to be affected by these. Moreover, cooling inflation and imminence of negative inflation might not be very much relevant to the Philippine economy. It has been clear in the past that the Philippines was often to experience high inflation that was countered to reach such a point in targeted inflation rate. But it does not remove the importance of inflation in the local economy. Meeting the target inflation rate that is follows a moderate inflation promotes growth to the economy and raises the living standards of the citizens. Having this said, people should be much aware in dealing and digesting the reported inflation rate in a specific period. Exposure to these types of discussion hopefully will lead to informed choices yielding better results for the citizens either for personal or creation of policies. Since accounts of downplaying the severity of the inflation rate volatility have been made by local agencies to tame the masses due to this subject.

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