In Partial Fulfillment of the Requirements

in Economics 1- Inflation

Presented to:

ERNIE LEX D. DE LA SALDE, LFT, DPA, FRIEdr

Presented by:

ERIKA JING CAMPANA

October 1, 2019
I. Rationale

Nowadays in economic, inflation is a sustained increase in the general price

level of goods and services in an economy over a period of time. When the general
price level rises, each unit of currency buys fewer goods and services;
consequently, inflation reflects a reduction in the purchasing power per unit of
money, a loss of real value in the medium of exchange and unit of account within
the economy. When prices rise for energy, food, commodities, and other goods and
services, the entire economy is affected. Rising prices, impact the cost of living, the
cost of doing business, borrowing money, mortgages, corporate and government
bond yields, and every other facet of the economy. Once our cost of living
increases, our power to purchase certain goods and services will decrease since it
decreases the value of our Philippine Peso. Inflation occurs due to an imbalance
between demand and supply of money, changes in production and distribution cost
or increase in taxes on products. When economy experiences inflation, for instance
when the price level of goods and services rises, the value of currency reduces.
This means now each unit of currency buys fewer goods and services. It has its
worst impact on consumers. High prices of day-to-day goods make it difficult for
consumers to afford even the basic commodities in life. This leaves them with no
choice but to ask for higher incomes. Hence the government tries to keep inflation
under control.
Consequently, Thornton (1998) found that monetary authorities seeking to
target inflation face the complication that some changes in prices are permanent
and others are transitory. The resulting volatility of measures of total inflation has
led to the development of “core” inflation rates that attempt to identify permanent
trends in inflation by eliminating transitory price fluctuations. Many economist argue
that these core rates are the formation of inflation expectations. This note examines
the times series properties of a measure of core inflation for consistency with the
time series properties of total inflation in Colombia and uses co integration and
error-correction techniques to test the usefulness of core inflation as a forecast of
total inflation in the country. For this reason, the Asian Development Bank (ADB)
said that monetary conditions are now more favorable with the taming of inflation,
which pushed food prices higher in the Philippines in 2018. As reported by the
National Economic and Development Authority (NEDA), Inflation in June 2019
eased to its slowest pace in 22 months, but we still need to caution against upside
risks, including weather-related shocks and uncertainties in the global oil market.
Slower inflation comes with the optimism that the quality of life will improve along
with the economy’s robust growth. The government will continue putting in place
preemptive measures to mitigate the impact of weather-related shocks and
uncertainties in the international oil market. The government will moderating its
effects on inflation. Furthermore, Inflation or the rate of increase in the prices of
goods remained within the desirable range for the 6th straight month, according to
the Philippine Statistics Authority.
In the Philippines, the volatility of inflation has been caused by factors such as
disturbances in agricultural food supply or movements in international oil prices. As
a result, the headline inflation rate may reach double-digit levels, even though the
prices of other CPI components show only mild increases (BSP, 2019). The inflation
rate for consumer prices in the Philippines moved over the past 39 years between
0.7% and 50.3%. In comparison to other countries, the drastic price increases are
no longer on average. Usually this is a sign of political and economic turmoil. To
point out, Inflation is always going to be a mix of international and domestic factors.
One obvious suspect is the continuing rise of oil prices worldwide. Countries with
no substantial oil production to speak of – like the Philippines – are forced to import
oil. Consequently, they are at the mercy of global oil price movements determined
largely by supply and demand (Punongbayan, 2018). Next, the factor that
contributes to runaway inflation is the weakening peso. Because we pay imports in
foreign currencies, a weaker peso necessarily makes imports costlier. As such, oil
becomes costlier too, as well as all the other goods and services in the economy
that rely on it. But perhaps the biggest – and most underappreciated – factor behind
inflation is people’s expectations of inflation.
Recently,The Bangko Sentral ng Pilipinas (BSP) maintains monetary policy
settings 'for the time being' as it expects lower inflation in 2019 and 2020.The BSP's
Monetary Board maintained the interest rate on the overnight reverse repurchase
facility at 4.5%. The interest rates on the overnight lending and deposit facilities
were also held steady.The lower inflation forecasts are due to the decline in global
oil prices and the strengthening of the Philippine peso, according to BSP Deputy
Governor Diwa Guinigundo. As stated by the Central Bank, The Monetary Board
believes that the manageable inflation outlook and firm domestic growth prospects
support keeping monetary policy settings steady for the time being.
Moreover, Frey and Stutzer (2002) integrate insights and findings from
psychology, where attempts to measure quality of life are well-documented, as well
as from sociology and political science. They demonstrate how micro- and macro-
economic conditions in the form of income, unemployment, and inflation affect
happiness. The research is centered on Switzerland, whose varying degrees of
direct democracy from one to another, all within a single economy, allow for political
effects to be isolated from economic effects. An increase in the general price level,
inflation is disliked by the population. But a lot depends on what kind of inflation
takes place. When the price increase is anticipated, individuals can adjust to it. They
can make contracts that take into account that prices will be higher in the future. In
particular, they will ask for a wage increase in the future in order to compensate for
the loss in purchasing power of money. In contrast, if inflation is not anticipated or
comes as a shock, such adjustment is not possible. Wage earners, as well as
owners of nominal.
II. Literature Review

A. Literature and Studies

This portion of paper of paper presents the review of literature and studies
that have bearing on this investigation. Review of literature revolves around the
study about Inflation in the Philippines. Also, related studies are presented herein.

Impact of Inflation in Economic Growth

Much of economic literature in identified investment as the main channel
through which inflation impedes economic growth (see Fischer, 1993). Inflation
reduces growth by reducing investment and productivity growth; budget deficits also
reduce both capital accumulation and productivity growth. Examination of
exceptional cases shows that while low inflation and small deficits are not necessary
for high growth even over long periods, high inflation is not consistent with sustained
growth. More attention has been taken to deal with the effects of inflation on
economic growth. This is because price stability is considered as the key variable
to promote economic growth as well as sustainable development. The major
objective for many central banks is to maintain price stability with high growth rates.
As money loses its value people lose confidence in it as a medium of exchange.
The resulting effect is a fall in savings and consequently lower investment as well
as economic growth.
Knowledge of the factors that significantly affect inflation will enable economic
managers to target appropriate variables in their effort to maintain price changes at
a moderate level. Most econometric inflation models for developing economies are
based on mark-up over cost equations since external factors are readily
incorporated. The latter is essential for open economies like the Philippines.

Inflation Rate
Inflation expectations matter because they change how people behave. This
mentality applies to inflation as well. If people expect inflation to rise in the coming
months, not only will consumers hoard basic goods, but workers will also lobby for
higher wages, and firms will also revise their menus or price lists to safeguard their
profits. One of the key features of inflation targeting is greater transparency, which
means greater disclosure and communication by the BSP of its policy actions and
decisions. This Inflation Report is published by the BSP as part of its transparency
mechanisms under inflation targeting (BSP, 2008)
In addition, (Lopez, 2014) the general perception about inflation is that it is
damaging to the economy. Although the effect of inflation is far more damaging than
its benefits, we have to look at the long-term benefits as well. The course of inflation
phenomenon gives rise to other economic occurrences like currency exchange
rates, local stock movements, national income accounts and the like.
Likewise, (Mangahas, 2014) the most important empirical determinant of
both poverty and hunger is inflation in the cost of living. Even short-term spikes in
inflation are extremely painful for the poor. Inflation facing the poor is worse. The
government keeps a different index specifically for consumer prices facing the
bottom 30 percent of households in terms of income. Inflation in consumer prices,
without compensating inflation in their incomes, is what keeps the poor from sharing
in the benefits of economic growth.
In addition, Gordon (1975) economic research on the causes of inflation has
been primarily devoted to the theoretical and empirical study of the links between
government policy variables and the rate of inflation. While debate continues on the
process of short-run adjustment most economists are prepared to agree that in the
long run “inflation is always and everywhere a monetary phenomenon.” Abundant
empirical evidence has confirmed that the major historical accelerations and
decelerations of inflation-not only during wars and hyperinflations but also during
peacetime-have been accompanied by accelerations and decelerations in the rate
of growth of the supply of money. But confirmation of the connection between
money and prices is only the first and easiest step in the development of a full theory
of the causes of inflation, because it leaves completely unexplained the sources of
changes in money. The central task of a comprehensive theory of inflation is the
identification of the sources of differences in the rate of inflation and hence of
monetary growth across time in particular countries, and across countries at a given
time
Methods to Control Inflation
At first, Monetary Policy is one of the method to control the inflation. In a
period of rapid economic growth, demand in the economy could be growing faster
than its capacity to meet it. This leads to inflationary pressures as firms respond to
shortages by putting up the price. We can term this demand-pull inflation.
Therefore, reducing the growth of aggregate demand (AD) should reduce
inflationary pressures.
At the same time, Fiscal Policy is also the method to control inflation. The
government can increase taxes (such as income tax and VAT) and cut spending.
This improves the budget situation and helps to reduce demand in the economy. If
a country had high inflation and negative growth, then reducing aggregate demand
would be more unpalatable as reducing inflation would lead to lower output and
higher unemployment. They could still reduce inflation, but, it would be much more
damaging to the economy.
The BSP controls inflation through its conduct of monetary policy which is
done primarily by moving its policy interest rate. Adjustments in the interest rate for
the BSP’s overnight reverse repurchase (RRP) facility, the primary monetary policy
instrument, typically leads to corresponding movements in market interest rates,
thus affecting the demand by households and firms for goods and services. This,
together with the aggregate supply of goods and services, determines the level of
prices.
 B. Theoretical Lens
Different economists have presented different theories on inflation. The
economists who have provided the theories of inflation are broadly categorized into
two labels, namely, monetarists and structuralist.
Monetarists associated inflation to the monetary causes and suggested
monetary measures to control it.
On the other hand, structuralists believed that the inflation occurs because of
the unbalanced economic system and they used both monetary and fiscal
measures together for sorting out economic problems.
Market-Power Theory of Inflation
In an economy, when a single or a group of sellers together decide a new
price that is different from the competitive price, then the price is termed as market-
power price. Such groups keep prices at the level at which they can earn maximum
profit without any concern for the purchasing power of consumers.
According to the advanced version of market power theory of inflation,
oligopolists can increase the price to any level even if the demand does not rise.
This hike in price levels occurs due to increase in wages (because of trade unions)
in the oligopolistic industry.
The increase in wages is compensated with the hike in prices of products.
With increase in the income of individuals, their purchasing power also increases,
which further results in inflation.
Apart from this, some economists concluded that fiscal and monetary
policies are not applicable in practical situations as these policies are not able to
control rise in prices levels. These policies would work only when prices rise due to
an increase in demand.
Moreover, these policies cannot be applied to oligopolistic rise in prices,
which is due to increase in the cost of production. Monetary policy can reduce the
rate of inflation by raising the interest rate and regulating the credit flow in the
market. However, it would have no effect on the oligopolistic price as the cost is
transferred to the prices of goods and services.
Conventional Demand-Pull Inflation
The market power theory of inflation represents one extreme end of
inflation. According to this theory inflation exists even when there is no excess in
demand. On the other end, the conventional demand-pull theorists believed that the
only cause of inflation is the excess of aggregate demand over aggregate supply.
In full employment equilibrium condition, when demand increases, inflation
becomes unavoidable. In addition in full employment condition, the economy
reaches to its maximum production capacity. At this point, the supply of goods and
services cannot be increased further while the demand of products and services
increases rapidly. Due to this imbalance between demand and supply, inflation
takes place in the economy.
Structural Theories of Inflation:
Apart from the two extreme ends mentioned in the above, there is a middle
group of economists called structural economists. According to structural theory of
inflation, market power is one of the factors that cause inflation, but it is not the only
factor. The supporters of structural theories believed that the inflation arises due to
structural maladjustments in the county or some of the institutional features of
business environment.
Mark-up Theory:
Mark-up theory of inflation was proposed by Prof Gardner Ackley. According
to him, inflation cannot occur alone by demand and cost factors, but it is the
cumulative effect of demand-pull and cost-push activities. Demand-pull inflation
refers to the inflation that occurs due to excess of aggregate demand, which further
results in the increases in price level. The increase in prices levels stimulates
production, but increases demand for factors of production. Consequently, the cost
and price both increases.
In some cases, wages also increase without rise in the excess demand of
products. This results in fall in supply at increased level of prices as to compensate
the increase in wages with the prices of products. The shortage of products in the
market would result in the further increase of prices.
Therefore, Prof. Gardner has provided a model of mark-up inflation in which
both the factors, demand cost, are determined. Increase in demand results in the
increase of prices of products as the customers spend more on products.
On the other the goods are sold to businesses instead of customers, then
the cost of production increases. As a result, the prices of products also increase.
Similarly, a rise in wages results in increase in cost of production, which would
further increase the prices of products.
So according to Prof Gardner, inflation occurs due to excess of demand or
increases in wage rates; therefore, both monetary and fiscal policies should be used
to control inflation. Though, these two policies are not adequate to control inflation.
Bottle-Neck Inflation:
Bottle-neck inflation was introduced by Prof Otto Eckstein. According to him,
the direct relationship between wages and prices of products is the main cause of
inflation. In other words, inflation takes place when there is a simultaneous increase
in wages and prices of products. However, he believed that wage push or market-
power theories alone are not able to provide a clear explanation of inflation.
After analysis of inflationary situation, Prof Eckstein says that the inflation
occurs due to the boom in capital goods and wage-price spiral. In addition, he also
advocated that during inflation prices in every industry is higher, but few industries
show a very high price hike than rest of the industries.
These industries are termed as bottle-neck industries, which are
responsible for increase in prices of goods and services. In addition, Prof. Eckstein
advocated that concentration of demand for products of bottle industries results in
inflation.
III. Government Intervention and Alternatives

The National Economic and Development Authority (NEDA) is the country's

premier social and economic development planning and policy coordinating body
primarily responsible for formulating continuing, coordinated and fully integrated
social and economic policies, plans and programs.
An act creating the Mindanao Development Authority (Minda), defining its
powers and functions, providing funds therefor and for other purposes. Declaration
of Policy. - It is hereby declared a policy of the State to accelerate the
socioeconomic growth of Mindanao, increasing its trade, tourism and investments,
encouraging private enterprise and advancing efforts towards peace and
development. Towards this end, an effective institutional mechanism shall be
established to address the need for a coordinated and integrated approach in the
formulation and implementation of various Mindanao-wide inter-regional
development plans, programs and projects.
The Bangko Sentral ng Pilipinas (BSP) main responsibility is to formulate
and implement policy in the areas of money, banking and credit, with the primary
objective of maintaining stable prices conducive to a balanced and sustainable
economic growth in the Philippines. The BSP also aims to promote and preserve
monetary stability and the convertibility of the national currency. The BSP controls
inflation through its conduct of monetary policy which is done primarily by moving
its policy interest rate.
The National Economic and Development Authority expects the Rice
Liberalization Act to further bring down the price of rice as inflation slows down to
its lowest rate in 35 months. The Rice Liberalization Act (RLA) continues to help
increase rice supply in the country. This allows more Filipinos to access cheaper
rice. This is especially helpful since a large number of families spends almost 30
percent of their total food expenditure on rice.
The administration of President Rodrigo Duterte was quicker in addressing inflation
than any of its predecessors, according to the Philippine Department of Finance
(DOF).
The administration of President Rodrigo Duterte was quicker in addressing
inflation than any of its predecessors, according to the Philippine Department of
Finance (DOF).
Finance Undersecretary Gil S. Beltran, DOF chief economist, said in a
report to his boss, Finance Secretary Carlos G. Dominguez, that the Duterte
administration was able to tame inflation, which averaged 5.6 percent last year, in
11 months.
The country was hit by high consumer prices four times in the past 15 years
but it took a shorter time for the Duterte administration to control the inflation rate,
which surged to a 10-year high in 2018, according to Beltran’s report.
The rate of increase in prices of basic commodities reached 4.3 percent in
March 2018, exceeding government targets. It eased last February to 3.8 percent.
The government announced that prices of basic goods and services rose at their
slowest pace in almost three years in August as the effects of the Duterte
administration’s anti-inflation measures, especially the controversial rice tariffication
law, began to take root across the economy.
According to the Philippine Statistics Authority, headline inflation rate
decelerated further to 1.7 percent last month, marking the lowest consumer price
index level since the 1.8 percent recorded in October 2016.
Among the various government bodies, the Bangko Sentral ng Pilipinas
(BSP) is uniquely qualified to promote price stability because it has the sole ability
to influence short-term market interest rates. By influencing short-term interest
rates, the BSP is able to affect the demand of households and firms for various
goods and services. Domestic demand and the aggregate supply of goods and
services determine the general price level. In addition, as the Philippines’ central
monetary authority, the BSP is tasked to promote price stability conducive to
balanced and sustainable economic growth. This is mandated by law under the
provisions of Republic Act No. 7653, also known as the New Central Bank Act,
which was passed into law on 10 June 1993. Achieving price stability is a universal
goal shared by central banks and monetary authorities all over the world. This does
not mean, however, that the BSP pursues price stability to the exclusion of other
objectives. Although the price stability objective is the BSP’s main priority, other
economic goals—such as promoting financial stability and achieving broad-based,
sustainable economic growth—are given consideration in policy decision-making.
Thus, the BSP coordinates with other government agencies to make sure that its
policies are part of a consistent and coherent overall policy framework.

IV. Recommendation
This studies discussed Inflation Rate in the Philippines, its effect to the
economy and how the country handle it over time. The studies looks into the
macroeconomic issues that affects economics. It focuses on the main points about
inflation. This will cover how inflation are being measured, the effects on demand
and supply and analyse the relationship of inflation to the Philippine economy.
All government’s ultimate goal is to maintain a strong and sustainable
economy but there are so many factor to consider in making it work right. Economic
is a complicated matter but is very important. The government is there to look after
its people and one of their goal is to provide everyone a better/higher standard of
living. In this research we would like to look at the Philippine economy using the
concept of Inflation and will extend the report to the importance of GDP.
One popular method of controlling inflation is through
a contractionary monetary policy. The goal of a contractionary policy is to reduce
the money supply within an economy by decreasing bond prices and
increasing interest rates. This helps reduce spending because when there is less
money to go around, those who have money want to keep it and save it, instead of
spending it. It also means that there is less available credit, which can
also reduce spending. Reducing spending is important during inflation because it
helps halt economic growth and, in turn, the rate of inflation.
Inflation is a fixture in the economy. To our fellow Filipino, the best way to
combat it is to prepare for it. One of the things consumers can do to inflation-proof
their life is invest. Invest in assets that grow in value over time, such as stocks or
real estate. And invest in yourself. Always strive to learn new and in-demand skills.
Nothing is more powerful than boosting your earning power. For businesses, it’s
advisable to raise selling prices in small amounts rather than one big jump. Some
of your competitors would probably do the latter; that gives you an edge to win more
customers. Make sure you have cash reserves to help you with surging costs. With
the onslaught of inflation, costs often rise faster than you can increase your selling
price. You can also try to renegotiate contracts with suppliers who may be willing to
give you discounts for pre or bulk orders. Finally, mind your margins and focus on
earning profits from the get-go, not just during tough times.

V. Referencing

“Inflation.” Wikipedia, Wikimedia Foundation, 22 Sept. 2019,

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Institutions Affect Human Well-Being. PRINCETON; OXFORD: Princeton
University Press. Retrieved from http://www.jstor.org/stable/j.ctt7rm1k

Thornton, J. (1998). DOES CORE INFLATION HELP FORECAST TOTAL

INFLATION? EVIDENCE FROM COLOMBIA. Cuadernos De Economía, 35(106),
407-413. Retrieved from http://www.jstor.org/stable/41951329

Summary Inflation Report Consumer Price Index (2012=100): August 2019,

Philippine Statistic Authority, 5 Sept. 2019, psa.gov.ph/price-indices/cpi-
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“Philippines Inflation Rate.” Philippines Inflation Rate | 2019 | Data | Chart |

Calendar | Forecast, tradingeconomics.com/philippines/inflation-cpi.

“JULY INFLATION SLOWEST IN 31 MONTHS.” The National Economic and

Development Authority, 14 Aug. 2019, www.neda.gov.ph/july-inflation-slowest-in-
31-months/.
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Economics, 18(3), 807-836. Retrieved from http://www.jstor.org/stable/725066
Fischer, and Stanley. “The Role of Macroeconomic Factors in Growth.” NBER, 1
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Core Inflation – BSP www.bsp.gov.ph › downloads › Publications › FAQs › inflation

http://www.bsp.gov.ph/downloads/Publications/FAQs/inflation.pdf
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