Signs and Wonders

Before the end of 2020, columnist professor Tyler Cowen in Bloomberg Opinion wrote that “it is not likely that the next major macroeconomic problem will be inflation.” At least in the US, he argued that inflation “has come in the form of lower quality, not higher prices.” His illustrations were very interesting. While schools have not increased their tuition fees, students are challenged by on-line learning. Getting treatment in a hospital or eating in a restaurant is more often than not accompanied by fear and inconvenience.

We can relate to these American experiences. They are very real in the Philippines. However, there is another side to Cowen’s argument. Other economists like University of Michigan’s Justin Wolfers, writing for New York Times, claimed that “the cost of living has risen during the pandemic, especially for poorer Americans.” He wrote that the pandemic has made life more expensive than what the statistics suggests. His hypothesis was that real output, real wages and poverty are calculated using inflation measures that do not capture the real cost of living during a pandemic.

COVID-19 (coronavirus disease 2019) has forced ordinary citizens to buy more essentials like groceries, pushing their prices up, while cutting down on airfare, gas, and clothing, pushing their prices down. On-line shopping with delivery charges and premium relative to over-the-counter purchases masks higher inflation because what the statistics reflect are those in the shops that are probably stable or with some discounts. Statistics may fail to capture the pandemic-induced more expensive on-line shopping.

Again, Filipinos can relate to these experiences. We also pay for the higher cost of this mode of transaction in this new normal.

The Economist (Dec. 10, 2020) has a somewhat similar take. Admitting that economists share the view that inflation is dead, The Economist wrote that “the premise of low inflation is baked into economic policies and financial markets.” This view explains why central banks could cut their policy rates to near zero or in real terms, negative. They are so emboldened as to expose themselves to enormous government debt through government securities purchases or outright loans to the government. The probability, even if small, of ending up “in an era of higher inflation” is something policy makers should worry about because sovereign indebtedness has swollen and central bank balance sheets have become awfully large.

In the same spirit, London School’s Charles Goodhart warned us last year (Inflation after the pandemic: Theory and practice, June 13, 2020, VOX EU) that eventually, the drop in the velocity of money “will revert back towards normality” and nobody can ever dismiss the impact of currently excessive monetary growth on inflation. While the output gap in many countries including the Philippines remains negative, we cannot ignore the potential dangers. To do this, in Goodhart’s colorful language is “the equivalent to an ostrich putting its head in the sand.”

Does the Bangko Sentral ng Pilipinas (BSP) need to formulate an exit strategy of its current expansionary monetary policy?

We all know that to assist in the whole-of-government pandemic management and economic recovery efforts, the BSP brought down the cost of borrowing by reducing its policy rate by a cumulative 200 basis points to 2%. This action dropped its policy rate to lower than the 2.6% inflation in 2020 and 4% expected inflation in 2021 and 2.7% in 2022.

In addition, more liquidity was injected into the system in various ways. The required reserve ratio was dropped resulting in more than P200 billion additional money supply. The BSP also allowed alternative compliance with the required reserve through loans to small business, releasing more than P160 billion. The National Government (NG) also borrowed from the BSP some P540 billion or 3% of GDP. The most substantial infusion of liquidity came from the BSP’s purchases of government securities in the secondary market amounting to about a trillion pesos. The BSP, instead of crediting it to its own capital pursuant to its new Charter, remitted P20 billion to NG.

All in, nearly two trillion pesos should be mopped up, in full or in part, depending on both growth and inflation dynamics moving forward. This is not a small amount; it is around 11% of GDP.

Of course, in a pandemic, monetary policy has limited use. With an economic lockdown and restricted mobility, cheap and abundantly available credit is not sufficient to boost confidence and inspire business activities. Flattening the pandemic curve and available vaccines will. Expansionary fiscal policy is more appropriate as it can directly address the need to allocate funds to fight the pandemic through strong health protocols, secure the vaccines and achieve herd immunity.

Yet, P2 trillion and negative real policy rate failed to bring the Philippine economy back to life in 2020. While domestic liquidity was more than ample, bank lending actually declined because the banks remained risk averse and tightened their credit standards instead. Banks chose to be procyclical and they stand to see their bad loans swelling.

Economic scarring is here to stay. For a while.

Which makes monetary policy exit strategy indispensable.

It would be a huge challenge to navigate between the devil of future inflation and the deep blue sea of sustaining policy support to economic recovery at this precarious time.

While the BSP maintains that the risks to inflation in 2021 are broadly balanced, its inflation forecast for 2021 of 4% is already at the high tipping point of 2-4% target. Its recent uptick at 4.2% in January might be repeated in February unless the supply shocks are decisively addressed. Otherwise, we should anticipate second round effects to entrench higher inflation. Inflation expectations might sway beyond control. As the global economy bounces back, oil prices are expected to climb, even beyond $60 per barrel. Once the peso reverses its appreciating trend, more inflationary pressures could be generated. Most important, the excessive easing of the BSP last year could make inflation the next macroeconomic challenge.

This is the target of the exit strategy.

On the other hand, the economy remains in recession and therefore policy support cannot be withdrawn as yet. This posture is necessary because in all the broadsheets last Tuesday, President Duterte made a statement that “after the Philippines received its first supply of coronavirus vaccines, Filipinos may expect to return to normalcy by 2023.”

The President must be quoting The Economist Intelligence Unit which released the chart above citing the date when selected countries may be expected to inoculate at least 60% of their population to attain herd immunity. First among them would be Hong Kong, Singapore, and Taiwan which are all expected to do it by the fourth quarter of 2021. The other ASEAN countries of Vietnam, Brunei, Thailand, Malaysia, and Indonesia are expected to complete it ahead of the Philippines’ fourth quarter 2023. By all means, the Philippine government can choose to accelerate its own timetable and show it is capable of doing things right. With more than P82-billion budget for the vaccines, this is not impossible.

The BSP, by announcing its exit strategy to attain normalcy, could help avert some negative repercussions of the Palace’s statement. Foundation for Economic Freedom President Calixto Chikiamco was correct in saying that this pronouncement “will damage and delay the country’s economic recovery.” The chilling effect on consumption, lending, and investments cannot be underestimated.

An exit strategy will serve as a forward guidance on how the monetary authorities plan to establish normalcy in the conduct of interest rates and money supply. The BSP can cite the signs that would trigger the exit strategy. Key movements in prices and business activities as well as in actual and expected developments in money supply and credit should be defined. Financial stability risks cannot be ignored because excessive money injection could bring about mispricing of risks.

Phasing down of monetary support could be tricky. It would be good for the BSP to avoid painting itself in a corner and committing to a predetermined amount of phasing down. Conditions could change but having a framework for normalization inspires hopes for a quicker pace.

Going back to Goodhart, an exit strategy that is credible to civil society could provide the BSP the basis for withdrawing monetary support when it is necessary while avoiding political pressure. Central bank independence remains a precious commodity; its inflation is more welcomed than avoided.


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.