OF SUBSTANCE AND SPIRIT
We have been participating almost every year in the Asian Development Bank’s (ADB) Asian Regional Forum on Investment Management of Foreign Exchange Reserves, before and after my retirement from central banking in 2019. While there was some lull during the pandemic in 2020, which actually provided ADB with a new angle. In our spirited one-on-one session in Sapporo, Japan last September, the Bank’s Deputy Treasurer Sukhumarn Phanachet asked about the important lessons of the health crisis for central banking.
There were many for emerging markets, but for us, the key lesson is the need for monetary authorities to ensure that non-monetary measures were also deployed in the relentless fight against inflation. Rapid price movement was not a problem per se during the pandemic and the year after. Inflation in the Philippines averaged only 2.4 percent and 3.9 percent, respectively, both within target. We are all familiar with the story, why — the Philippine economy was literally locked down. Any imbalance in supply and demand was suppressed by restricted business activities.
But the next two years were nightmares for both the central bank and the government.
Both headline and core inflation rates reached their peaks, breaching the two to four percent official inflation target, indicating that both supply and demand factors could not have been busier at work. Unfortunately, while the BSP managed domestic demand by appropriate monetary tightening, there was some difficult challenges on the supply side.
The unprecedented monetary and fiscal support during the pandemic did not elicit appropriate response from the severely constrained business activities. Firms were not fast enough to increase their output and meet higher domestic demand. Add to this mismatch is the supply disruptions in rice, onion, garlic, meat, fruits, and vegetables.
In all the press statements and forward guidance issued by the BSP in the last two years, the need for more strategic supply-side initiatives had been consistently hammered. Of course, like the US Federal Reserve at some point before that, the BSP was less careful in looking through the supply side. For that matter, many central bankers had thought those significant price movements of rice, oil and other basic commodities were transitory. Many of them held that monetary policy could just observe and sit out their ultimate return to more normal levels.
We are wiser now, knowing they never reverted soon enough, and as a result, monetary tightening was deployed quite late in the day. The market had begun to factor in these persistent price increases in their view. Inflation expectations were de-anchored and inflation even got more entrenched.
In the Philippines, therefore, it was correct for the BSP to have sustained contractionary monetary policy until they were convinced of the more definite decline in headline and core inflation rates. With the emergence of new risks to inflation and the peso, we share the BSP position to avoid a more substantial easing. They can afford to be more patient in monetary unwinding because the economy has remained resilient.
This narrative is no different from what happened and what is happening in the global economy today.
As highlighted during last week’s Annual IMF-World Bank Meetings by the presentation of the October 2024 World Economic Outlook “the decline in inflation without a global recession is a major achievement.” True, the surge of inflation after the pandemic and the subsequent decline in inflation recently demonstrated what the Fund described as a unique combination of serious supply disruptions, strong domestic demand and geopolitical crisis courtesy of the war in Ukraine and lately what started in the Gaza strip.
The importance of supply dynamics in the fight against inflation was captured by the Fund’s research showing “an upward shift and a steepening of the relationship between activity and inflation, the Philips curve.” It was the tight monetary policy and labor market stabilization that bought time for those supply logistics to ease. Monetary policy kept inflation expectations hinged which, in turn, helped keep wages broadly aligned. In other economies, though, wage adjustments were actually overdue and the surge in inflation simply made it exigent.
Is the worst over for the global economy?
If the Fund Managing Director Kristalina Georgieva’s take during the press conference of the International Monetary and Financial Committee (IMFC) last Oct. 25 is to be the defining view, there is now a good balance between confidence and caution. We can be confident that the global economy is more resilient than we first thought and that price movements are essentially stabilizing. Public policies tamed inflation without significant disruption to economic growth. But we have to keep our guard up. Caution is imperative because even if inflation is trending down, price levels remain very elevated. More people are getting poorer. The prospect for low growth and high debt exists especially in emerging and developing countries. Trade and finance fragmentation complicates growth as it is driven by wars, security concerns and competitiveness.
Against these new challenges, the Fund expects some policy gears to refocus. Central banks need to continue remaining attentive, always looking for evidence, to guide them towards an even conduct of monetary policy, that which is neither too late nor too early. We should add that correct judgment is also critical on the amount of the adjustment. Otherwise, it could affect disinflation or growth, or worse, both, even if perfectly timed. Communication is key to keeping inflation expectations well anchored.
On the fiscal side, fiscal consolidation should be pursued at all costs. The problem is that with the extraordinary accommodation of the pandemic, fiscal buffers have thinned out. Since taxation is not necessarily the preferred route of many governments, many economies seem to be borrowing their way to economic growth. What is worse is that, and we hope this is not the emerging option for the Philippines, some governments are borrowing their way out of debt!
Obviously, there is no substitute to abandoning business as usual. That will never bring us the spectacular quality growth that we badly need. Large infrastructure deficit, poverty, and income inequality in the Philippines require substantial and quality economic growth. We cannot always rely on more and more capital and labor, and so we should aim for greater productivity and economic efficiency mainly through technological innovation. Most important, good growth is impossible if our political leadership cannot even solve the issues of corruption, and yes, floods!