Is current inflation worrisome?

Price increases have always been the people’s concern. Surveys time and again show that the people consider price increases as a main problem.
The poor and the working class are sensitive to the rise in prices of food, housing, water, electricity, transportation and health. An increase in the cost of basic goods is very visible for the poor people.

 

On the other hand, unemployment is not immediately obvious because the poor people work, despite the poor quality of employment, in order to survive. Hence, employment is perceived to be a secondary concern, relative to high prices or inflation.

This kind of perception affects the economics and politics of policy making. Some economists are inflation hawks. Politicians tend to favor policies that ostensibly bring down prices like free irrigation, free college education, and free rice, and oppose policies that increase prices of goods like taxes.

Not surprisingly, the media reinforce the fear of inflation under current conditions. Recently, a top news item of BusinessMirror was headlined “Low-inflation regime ends,” written by Blanca Cuaresma (11 February 2017). Citing an unnamed analyst, Ms. Cuaresma wrote: “While the end goal of the reforms is better infrastructure and a more equitable distribution of wealth, the analyst warned that if not administered properly, we may end up with faster inflation, credit downgrades as the fiscal house falls apart and, ultimately, slower economic growth.”

We must resist the bias for or obsession with so-called “low-inflation” at any cost. Basic macroeconomics informs us that in the short run, a trade-off between inflation, on the one hand, and output and jobs, on the other hand, does happen.

In the current context, consumer spending is heavy, which creates inflationary pressure. Production, however, is being constrained by bottlenecks in infrastructure and logistics. Thus, government needs to ramp up infrastructure spending, in which the resources will be generated from tax reform.

The country has yet to reach its production potential. And the economy is far from overheating. In this case, a reasonable higher inflation rate can be accommodated to accelerate growth.

Even in the long run, moderate inflation is not harmful to growth. It is worth returning to the oft-cited paper of Michael Bruno and William Easterly, “Inflation Crises and Long-Run Growth,” National Bureau of Economic Research (NBER) Working Paper No. 5209 (August 1995).

The Bruno and Easterly paper shows the evidence that moderate inflation is not injurious to growth. Moderate inflation is described in the Bruno and Easterly paper as a rate between 20% and 40%. In the aggregate, growth for the countries with moderate inflation was not significantly lower than previous growths of said countries or significantly lower than the world average. Some countries even had better growth than otherwise despite mild inflation, although the pattern was mixed. The breaking point leading to “truly damaging inflation crises” occurred at the inflation rate of above 40%.

I highlight the Bruno and Easterly’s observation that China, Taiwan, Korea, and Japan — or the East Asian miracles — had high inflation in the post World War II period. Their success “at the very least reinforces the conclusion from our recent data that inflation crises do not permanently damage growth!”

To return to present Philippines, we find that the inflation rate is significantly low. Consumer prices as of January 2017 rose below three percent. The Bangko Sentral ng Pilipinas forecasts an inflation rate of three percent for 2017 and 2018. The Department of Finance estimates that the inflationary effect of tax reform, particularly the rise in the excise taxes on petroleum products and the narrowing of exemptions on the value-added tax, is 2.6% on average. By all accounts, an inflation rate between five percent and six percent, already factoring in the tax reform, is benign.

Compare that with Bruno and Easterly’s moderate inflation that is between 20% and 40%. Or Rudiger Dornbusch and Stanley Fischer’s “Moderate Inflation,” NBER Working Paper No. 3896 (November 1991), in which moderate inflation ranges between 15% and 30%.

In short, the Philippines is not even experiencing moderate inflation, nor are we near moderate inflation.

Moreover, the inflation uptick arising from the tax reform will not result in the decline of real income of the poor and working classes.

The tax reform package includes temporary unconditional cash transfers — P500 per month for the poor belonging to the first to third income decile groups and P250 per month for the near poor belonging to the fourth and fifth decile groups. Those in the sixth, seventh, and eight decile groups (mainly the informal workers and minimum wage workers) will be given protection by way of the public transportation subsidy.

Moreover, the package includes the personal income tax relief by way of exempting incomes below P250,000 and lowering the tax rate to 25% that benefits all but one percent of the taxpayers.

All told, the income tax relief, the unconditional transfers and the public transport subsidy more than offset the income loss of the poor, the near poor, the workers, the middle class, and some sections of the upper classes from the moderate increase in consumption taxes.

So why worry over inflation, resulting from a tax reform program? It is a program that will increase spending for infrastructure, education, health and other public goods. It will enable the economy to sustain growth and expand jobs without destabilizing prices.

What should disturb us is the resistance by extreme populism to torpedo the hard part of the tax reform. This will lead to an unbridled budget deficit, an increase in interest rate, a loss of investor confidence, and ultimately a growth slowdown.

Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.

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