Overheating in the US, stagflation in the Philippines?

The International Monetary Fund (IMF), credit rating agencies, and investment bank analysts share a common assessment of the Philippines’ fiscal stimulus package. It’s not enough.

The issue in the US is its massive fiscal stimulus plan. Some fear it could produce overheating and high inflation.

Current US Treasury Secretary Janet Yellen and past US Treasury Secretary Lawrence Summers are slugging out the enormous size of the fiscal stimulus. At $1.9 trillion, the package proposed by US President Joe Biden is three times the estimated negative output gap of $665 billion as of the last quarter of 2020. The US Treasury intends to stimulate the economy by higher public spending. This is Biden’s countervailing force to weak private consumption and investment.

Summers is not actually opposed to the idea of stimulating the US economy in a big way. Bloomberg reported that in fact, he admits that during the Global Financial Crisis in 2008-2009, the US economy would have recovered faster with a bigger package than the $787 billion he succeeded in putting together.

What the former Treasury head questions is the sheer size of the package and the risks attendant to it. It is likely that spending an amount approximating the World War II package to deal with recession would trigger phenomenally high inflation. He wrote “I worry that containing an inflationary outbreak without triggering a recession may be even more difficult now than in the past.”

Summers is referring to the conventional monetary policy tools of jacking up interest rates and reducing domestic liquidity through tight open market operations. This combination could moderate price movements but it could also depress business activities. A prolonged drop in output gives way to another recession.

In answer to this warning, Yellen explained: “As Treasury secretary, I have to worry about all the risks to the economy. And the most important risk is that we leave workers and communities scarred by the pandemic and the economic toll that it’s taken, that we don’t do enough to address the pandemic and the public health issues, that we don’t get our kids back to work.”

We have no doubt our very own economic managers led by Finance Secretary Sonny Dominguez have been worrying as much about similar risks to the Philippine economy. Their worries must have multiplied during this pandemic and kept them awake at night. But Yellen’s retort might be instructive to our authorities. She is very emphatic that their government should one, ensure that workers and communities are brought back to active economic groove; two, spend on health measures, vaccines and the whole public health system to stop the virus from further infecting and killing people; and three, enable the safe return of students to school. It’s a whole of system approach that does not equate the economy with public health, and in the process, avoids an either/or decision. Competent and compassionate pandemic mitigation will surely allow the revival of the domestic economy.

To be sure, the broad strokes of the US package are not fundamentally different from those put together by our economic managers. Focus is given to soften the pandemic blows to the most vulnerable through cash transfers and small business support especially those in agriculture, transportation and tourism. Capital expenditure and infrastructure support will be sustained. Monetary policy will also accommodate the funding needs of the economy.

But our pandemic response is quite paltry. From the IMF’s monitoring, the chart below shows the extent of discretionary fiscal response to the COVID-19 crisis in emerging markets and middle-income countries. Out of 19 jurisdictions, the Philippines ranked 13^th in terms of additional spending on medical buildings, equipment, staff and medical supplies as well as foregone revenues as a percent of 2020 gross domestic product (GDP). At 2.5% of GDP, ours was below the GDP-weighted average for this group of countries, even behind India and Indonesia.

Using the same metrics, US’ additional funding for pandemic mitigation was a huge 16.7% of GDP.

Summers’ beef about the size of the fiscal support is beyond inflation and possibly a stock market bubble. He thinks it could undermine congressional appetite for future fiscal action to deal with long-term agenda like infrastructure spending and climate change. Excess in one could mean too little for the other.

Biden thinks otherwise.

“Some in Congress think we’ve already done enough to deal with the crisis in the country. Others think that things are getting better and we can afford to sit back and either do little or nothing at all… that’s not what I see. I see enormous pain.”

Yellen focused Biden’s point by clarifying that the US Government will launch yet another package to deal with these long-term fundamental problems like weak public investment. That means a bigger total package and bigger potential for what Summers described as “inflationary pressures of a kind we have not seen in a generation.”

It is true Bloomberg shows that so far, investors appear to have just shrugged off inflation concerns. What worries the market is instead the issue about financial stability as excessive liquidity swamps different asset markets, ultimately leading to a crash. History shows this to be true in 2000 and again in 2007.

In Japan, a similar concern about excess liquidity was expressed by a Bank of Japan (BoJ) board member when he said: “…by buying huge amounts of assets and holding onto them for a prolonged period, the BoJ could affect market functions. That is something we need to be mindful of.”

These, meaning inflation and financial instability, might as well be the cost of reversing job losses which the US Congressional Office said could take until 2025 to restore to 4% again from January’s 6.3%. Unemployment is the modern scourge and Yellen considers it synonymous to “tremendous suffering in the country.” To her, this must be addressed as it is the biggest risk.

Yellen’s argument is imperative because of the continuing uncertainty posed by the pandemic despite the general roll-out of the vaccines. Black workers, women, and those in low-paying jobs are likely to become unemployed.

That brings us back to the Philippines where some bank analysts have raised the specter of stagflation, the threat of stagnant growth and rising inflation. While Yellen and Summers are sparring on the issue of potential overheating, here we are struggling to climb out of an economic recession.

At this point, we cannot be too pessimistic based on actual evidence. Yes, we are probably in a prolonged economic slowdown after last year’s deepest recession due to pandemic-induced economic scars. If only for base effects, we should be able to show some modest positive real GDP this year and perhaps next year. While the Philippines lags behind the ASEAN and other emerging markets in managing the pandemic and economic recovery, the early economic revivals in other economies could help boost its external payments position and contribute to growth. ADB’s Director for Regional Cooperation Cyn-Young Park also said recently: “I do believe that the Philippines has a strong potential given that its post-pandemic trade landscape will give more weight on the digital and services trade.”

But it would be ambitious to add that we could recover the pre-pandemic growth levels this year or even early next year.

Our favorite caveat is that our health authorities should never, never drop the ball ever again in vaccine sourcing and administration. Despite all the noise on vaccines’ side-effects due to co-morbidity and allergy factors, the US and UK experience shows they have started to bring down the pandemic curve. This was reported by the Financial Times based on the seven-day rolling average of new cases. In short, vaccines work and if they do, promptly rolling them out in the Philippines could reduce risk aversion, increase mobility and business activities.

On inflation, the challenge is to manage the supply side which is no different from saying we should grow the economy. Cost-push inflation is usually non-persistent but if we continue to see some improvements in domestic demand and monetary policy remains excessively easy, that could entrench high inflation. With early recovery and an OPEC (Organization of the Petroleum Exporting Countries)  oil cutback, increasing oil prices can be an upside risk. The Bangko Sentral ng Pilipinas should not be carried away by a more accommodative stance. Heavy lifting should yield to heavy monitoring of high frequency mobility indicators of Google, Apple, and Waze; equity and bond price indices; debt and credit default swap spreads; and FX daily and intra-day movements. These will help the Monetary Board handle the delicate balancing act.

No, stagflation is not around yet but we should be cautious not to welcome and abet it with open arms but closed eyes.

Diwa C. Guinigundo is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001–2003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.