Bangko Sentral ng Pilipinas kept its benchmark interest rate unchanged at 6 percent on Aug. 23 after lowering borrowing costs in July for the first time since 2003 to spur growth. The expanding economy and ``manageable'' inflation allows the central bank to ``maintain a neutral policy stance,'' Governor Amando Tetangco said on Aug. 30. Article continues…
Clarissa Batino and Michael Munoz. Philippine Inflation Probably Accelerated as Growth Quickened.08/09/2007
The Philippine economy is experiencing great levels of economic growth (a), due to healthy levels of spending by the population. Although this desired economic growth will have led to a decrease in the unemployment (b) rate, it has however accelerated the inflation (c) rate in the economy.
Increased ‘sales of homes, mobile phones and fast-food’ are the main goods responsible for bringing about economic growth and hence increase the inflation rate. The increasing inflation rate is a simple case of demand-pull inflation, where “inflation occurs as a result of increasing aggregate demand in the economy” (Economics Course Companion). The monetarist policy (d) applied by Bangko Sentral ng Pilipinas in the month of July, where the interest rates were decreased to encourage spending in the economy and spur economic growth, is responsible for the inflation that is being experienced in August. This economic phenomenon is depicted below:
Figure 1: Demand-Pull inflation- when Approaching Full Employment Level of Output
Where the AD1 curve cuts the LRAS curve, the Philippine economy is near but not at full employment level. Due to the lowering of interest rates by the Philippine authorities, the aggregate demand in the economy increases, which is depicted by the shift outwards of the AD curve from AD1 to AD2. This leads to economic growth where the real output increases from Y1 to Yf, however it also leads to an increase in the average price level from P1 to P2, and hence the AD shift is inflationary.
At the moment, inflation rate is ‘manageable’ and any interference in the market may hamper the goal of achieving economic growth. However, it is predicted that ‘Philippines’ $117 billion economy may expand 7.1% this year’, which ‘exceeds the forecasts of the government’ which is embarking on new projects and hence planning to inject money into the economy. This may turn into a dangerous situation for Philippine, if the economy is already at full employment level. Any increases in spending may turn out to be pure inflationary.
Figure 2: Demand-Pull inflation- At Full Employment Level of Output
In the diagram above we can see that the economy is at full employment level where AD1 cuts the LRAS curve at point A. Any increases in aggregate demand in the economy will have no effect on the real output, but will be purely inflationary, as depicted by the shift of AD1 to AD2, where the average price level increases from P1 to P2, without any consequent rise in real output.
If this situation occurs in the Philippine government, it can be quite harmful to the economy. This is due to the ill effects brought about by inflation. Philippine may start becoming less competitive in the international market if it experiences higher inflation rates compared to its competitors like Malaysia and China. This can then lead to deficits in the balance of payments account. Furthermore, the uncertainty caused by inflation may inhibit investment in the economy hence reducing the potential economic growth of the economy. Life-time savings of individuals can be eroded in a matter of months if inflation runs out of control, leading to lower standards of living for the population. Furthermore, borrowers gain at the expense of lenders, and people on fixed incomes may suffer due to a loss of purchasing power. All this would lead to increased inequality of income, and hence poor living standards. These are but a few effects of inflation, and hence making achievement of low-levels of inflation a macroeconomic target for most governments.
There is a way for the Philippine government to achieve economic growth, without disrupting the inflation rate in the economy. This can be done by striking a balance between supply-side policies and demand-side policy. This means that the Philippine government can increase the aggregate supply in the economy, to pave way for the increasing aggregate demand. A few of the supply-side policies include reduction in income taxes to provide incentive to workers to work harder, eliminating minimum wages, reducing unemployment benefits to push the unemployed to find work and privatisation of public firms so as to improve efficiency. However, these policies have drawbacks too, some of which include the fact that they take a long time to kick in, can reduce government revenue and reduce considerably living standards of the poor. Therefore, it is a necessity for the Philippine government to strike the right balance between which supply-side policy to use, and when to curb the aggregate demand in the economy.
Definitions:
a) Economic growth is a steady process by which the productive capacity is increased over a period of time( economics course companion)
b) unemployment is “people of working age who are without work, available for work and actively seeking employment” ()
c) Inflation is a sustained increase in the general price level.( )
d) Monetary policies are ones that use the level of the money supply and interest rates to influence the level of economic activity. ( )
