It's the stupid, economy!

To continue this piece on Boom and Bust: let me first tackle the second priority I listed earlier, which is stabilization. Mainstream economics agrees that aggregate demand (spending decisions of households, business, goverment, and the foreign sector put together) does play a role in the business cycle. Moreover, policies of the government (including the Central Bank) can influence aggregate demand a lot. Deficit spending by government, and monetary creation by the Central Bank (the equivalent of printing money), can stimulate aggregate demand. (These are referred to respectively as "expansionary fiscal" and "expansionary monetary" policies.) Reduction in deficit spending as well as contraction in money growth do the reverse.

Both tools should be exercised with caution though. Excessive deficit spending creates an unsustainable public debt. (That means, it gets so big nobody wants to lend to the government anymore.) Discretionary money creation makes people doubt about the actual purchasing power of the peso (given the unpredictable inflation it causes). Demand management is therefore a delicate balancing act.

Now stabilization policy should be "countercyclical". However, Leitner's study (cited earlier) provides evidence that fiscal and monetary policy is "procyclical"; expanding and contracting when the Philippine economy does. This suggests that government policies have aggravated the business cycle.

Why? One hypothesis is that economic managers have been incompetent (hence the title of this post.) However to be fair, maybe they weren't aiming at goals other than stabilizing the business cycle. On the monetary side, it turns out that all these years the Central Bank has not been targeting the business cycle at all! Rather, it was an informal policy of theirs to keep the exchange rate stable. Hey I'm not pulling this out of my hat; there's good evidence for this from a peer reviewed article by Bautista and Bautista (2005). How does this work? Well, high interest rates make peso-denominated assets more attractive, which increases demand for pesos from dollar-holders. Credit and money supply go together; keeping money supply tight keeps credit tight, which keps interest rates up. So this was the CB was after all these years.

This is the heritage of Oldthink - for decades the Philippines' foreign exchange market was heavily regulated (older readers in the Philippines can recall the "black market" for dollars and the "Binondo Central Bank.") This was in part to control the exchange rate. After liberalization in the early 1990s, the Central Bank still seemed captivated by Oldthink. And you know what? There are some bank economists who believe that the Central Bank is still in the Oldthink mode. See this article:

But Emma Pante, an economist at Rizal Commercial Banking Corp., said, "It may be difficult for the BSP to hold its key rate steady given the US Fed's continued hike in benchmark interest rate to between 4.0 percent and 4.25 percent by yearend." The BSP is being helped in keeping rates steady by the healthy levels of foreign portfolio investments and income remittances of overseas Filipino workers, "but still the oil price threat remains," Pante said. "As the nation's oil import bill rise, the peso will remain under pressure," she said."

That's Oldthink for you.

But the Central Bank itself professes radical departure with Oldthink. From 2000 onwards, it has adopted the textbook prescription of targeting inflation primarily, and other objectives (such as stabilization) secondarily. My opinion is that it's recent performance renders its goal-setting highly credible. (Let's hope then that they prove the economist quoted above wrong!)

Next: fiscal policy.