How not to be afraid
Stories are embedded in economics, as suggested by one of my favorite economists, Deirdre McCloskey. The story of the day is the nexus between inflation and debt — two sides of the same public policy coin.
We can take comfort in the official views on inflation and debt. And yet, we cannot ignore other stories that live rent-free in our ordinary-citizen minds. Inflation is not 5 or 6 percent. It is more like 20 percent if we stare at how food, housing, and transportation costs have risen. The fight against inflation requires central banks to maintain high interest rates and portends a business downturn. (Official data record inflation as a change over 12 months, although we can take a broader perspective considering how prices behave. Some are fixed for a while, while other prices fluctuate more often.)
Then there are the public debt figures. Our economic managers say that government debt is manageable. Such debt hovers around 60 percent of GDP, a line that the international financial institutions (the International Monetary Fund and the World Bank) have set up as representing the line of probity or responsibility for developing economies. If we let our debt figures cross this line, there could be something wrong with our economic policymaking. Is this moral story credible? Is there a story behind the official story? Are the economists in Washington scaring us out of our wits?
Other questions come to mind. Economics students at Silliman have suggested a laundry list of such questions. Among them are:
Is there a “looming crisis” related to inflation and debt in the Philippines?
Are inflation and debt related to “economic resilience”?
Is domestic inflation closely tied to US inflation? If so, why? More generally, will we see a global increase in inflation?
How soon can we expect inflation to return to the 2-4 percent target set by the Bangko Sentral?
When does public debt become “unsustainable”?
Does the economy’s reliance on remittances from abroad (the so-called OFW phenomenon) give us confidence amid inflation and debt problems?
I will address these questions.
Let me first review the basic facts regarding inflation and debt.
Inflation is tied like a Siamese twin to what the central bank does (what textbooks call “monetary policy”). The theory is that inflation is a “disequilibrium” event that requires a continuing expansionary impulse in the money market (where the central bank prints money to buy bonds) or in the goods market (where the government spends “too much”). Targeting inflation requires the central bank to limit its money creation, and its job would be easier if the government spent within the economy’s capacity. An equivalent but pessimistic conclusion is that an “easy” central bank cannot tame inflation, especially if politicians insist on playing Santa Claus all year.
Debt, the kind incurred by the government, is a consequence of “fiscal policy” as measured by the excess of government expenditures over taxes. There are understandable limits on how much taxes the government can collect. But there is also the strong temptation to spend on what some view as areas the government should shoulder — subsidies for farmers and favored industries like solar electricity, budgetary support for military and educational institutions, big-ticket infrastructures, etc. However, debt is never a problem if it pays for worthwhile expenses. The real problem with debt is a “knowledge” problem. How do we know if actual government expenditure has a “return on investment” that exceeds the interest cost on the debt? For advanced industrial countries, history favors the view that public debt is not a problem. One researcher (Bradford DeLong) has compiled centuries-long data showing that the North Atlantic economies can “grow out” of their debt problems because the long-run real interest rate is lower than the economy’s growth rate. Can we say the same about developing economies? Stanley Fischer has said that “there is no magic debt-to-GDP number.” The best approach is to treat the issue on a case-by-case basis.
Let me now return to the questions raised by the thoughtful economics students at Silliman.
First, is there a “looming crisis” related to inflation and debt? My answer is in the negative. The worst scenario is possibly a repeat of the “stagflation” of the 1970s, when “aggregate supply shocks” (mainly the oil price increases effected by the OPEC cartel) complicated the made-to-measure “demand management” recommendations of mainstream Keynesian economics. With hindsight, we can perhaps see that the tight monetary policy of the early 1980s under Volcker gave the OPEC cartel an excuse not to flex its control over oil prices. In any case, the crisis scenarios of the past are not in the cards as governments, including here in the Philippines, have become more cautious about their fiscal and monetary policies. Notably, commodity prices have generally not shown any persistent upward spiral since the onset of the Great Financial Crisis of 2008.
When does debt become unsustainable? The prime examples today are Turkey, Venezuela, and Sri Lanka. Those who invested in the bonds of these countries now worry if they will have to get a “haircut.” (A haircut is when a debtor country negotiates a “debt restructuring” where the debtor does not have to repay its debts in full or on the original schedule contracted.) The key players here are the “orchestrators” of debt restructuring — the international financial institutions and other official lenders. Of course, the root cause is the irresponsibility of the economic managers of these countries. Is the Philippines at risk of joining this unenviable group? Not now. Not yet, and we hope not ever. (We were in the same sad lot in the early 1980s, but that’s a long-ago story.) Still, even if we can easily avoid a debt restructuring, we may have to bear the burden of an abnormally high interest rate, thereby limiting the ability of the government to pay for essential services.
Can we relate debt and inflation to “resilience”? Can we rely on OFW remittances to keep the economy afloat amid inflation and debt problems? These questions reflect wishful thinking. Resilience is a nebulous concept at best. How do we “vaccinate” an economy for it to be able to deal with policies that raise inflation or cause debt to become unsustainable? An optimistic view is that the economy will be resilient if we have responsible officials. While that may be a pipe dream, I have no sympathy with the facile view that all is well because the Philippine economy is allegedly resilient.
Is domestic inflation correlated with inflation abroad? Yes, if domestic policies mirror what other countries do. Responsible central banks now vow to limit inflation to within the canonical 2-4 percent target. But good intentions and responsibility often yield to geopolitics. The Vietnam War eventually resulted in the inflation of the 1970s. Can we predict a repeat arising from the conflicts in Ukraine and the Middle East?
Can local inflation return to official targets soon? I hope so, but this is a challenging task. The Bangko Sentral is not the only actor in the inflation play. The government’s expenditures also matter. The research area here is called “inflation dynamics,” and economists have not quite figured out how to forecast the short-term time path of inflation.
What’s at the end of the inflation tunnel? A good outcome is likely under certain conditions. Wages will have to catch up with prices. Firms will, in turn, have to refrain from factoring wage increases in their future prices. Is debt a problem? As noted, we are not in the same category as other countries with severe problems. A Stoic would say that courage is the answer. A cynic would accept a high-interest rate scenario as a “new normal.” Take your pick.