Angelo Taningco
Economist, Treasury Group
Inflation targeting is the monetary policy framework of several central banks—including that of the US and the Philippines. The so-called Phillips curve postulates a trade-off between inflation and unemployment. In the Philippines, headline CPI inflation and the unemployment rate for 2017 averaged 3.2% yoy and 5.7%, respectively, both figures matching our forecasts. This year, we expect inflation to rise and unemployment to dip, with our forecasts at 3.6% yoy and 5.5%, respectively. We, however, submit that the Philippine Phillips curve has relatively flattened in light of the conduct of inflation targeting, and therefore may not be a reliable tool in forecasting inflation.
We observed that the Phillips curve has become a contentious issue in many developed economies. In the US, for example, core inflation has remained stubbornly low and persistently below the Federal Reserve’s 2% target despite the unemployment rate already falling to its lowest in 17 years. Moreover, US wage inflation has continued its sluggish pace despite the US economy close to if not already at full employment. There’s empirical evidence that the Phillips curve has flattened, i.e., the inflation-unemployment link has weakened, for several economies—including the US, posing challenges to the inflation targeting approach; in fact, minutes from the 12-13 December Federal Open Market Committee (FOMC) meeting reveals few of its participants suggesting a further study of alternative monetary policy frameworks such as nominal GDP and price-level targeting, both of which might be more optimal compared to the current framework.
For the Philippines, there is empirical evidence about the existence of the Phillips curve. However, a central bank study has highlighted a flattening of the curve over the years and may have partly been a result of the central bank’s adoption of inflation targeting in 2002. Using Philippine data, we depicted a negative but low correlation (−0.26) between inflation and unemployment spanning the 1977-2017 period. When we regressed inflation on unemployment, however, we found a statistically insignificant relationship. Using a time dummy variable, we statistically found that inflation has significantly gone down during the inflation targeting era, which spans the 2002-2017 period. We also measured inflation volatility over the years and found that it was substantially higher during the pre-inflation targeting period (1977-2001) than during the post-inflation targeting era. Against this backdrop, we think that inflation targeting has indeed helped mitigate inflation volatility and anchored inflation expectations, and therefore has contributed to the flattening of the Phillips curve in the Philippines.
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