1

AN EXAMINATION OF THE J-CURVE EFFECT IN THE PHILIPPINES

USING A BILATERAL APPROACH

A thesis manuscript submitted in partial fulfillment of the requirements for graduation

with the degree of Bachelor of Science in Economics, College of Economics and
Management, University of the Philippines, Los Banos. Prepared at the Department of
Economics under the supervision of Professor U-Primo E. Rodriguez.

ABIGAIL ALLISON MOMONGAN PERALTA

CHAPTER I

INTRODUCTION

1.1 Background of the Study

The Philippine trade deficit amounted to $55 billion in 2007. Before that, the trade

balance had already been in deficit since 2001. In fact, from 1990 to 2007, it only had

trade surpluses in 1999 and 2000 (NSCB, 2008). While still a subject of debate, the

overvalued exchange rate has been blamed as the prime culprit for the persistent trade

deficit of the country (Bautista, 2003). The overvaluation encouraged imports at the

expense of exports. The common argument for overvaluation is that as a developing

country the Philippines needs imported capital to grow (as cited in Lim, 1992). However,

huge and persistent trade deficits deplete foreign currency reserves needed to finance

debts (Yap, 1988) and seem to hold back growth (Fabella, 2004). Lim (1992) also
 2

pointed out that in a country severely in debt like the Philippines, exchange rate policy is

critically linked to foreign debt servicing.

The Philippines had a fixed exchange rate regime up until the 1980’s. The

Philippine exchange rate followed the Bretton Woods system of exchange rate parity

among IMF member-countries, and devaluations were done only in response to foreign

exchange crises (Bautista, 2003). Major examples include the devaluations of 1962,

1970, 1983, and 1984. Of these, only the devaluation of 1962 led to an improvement of

the trade balance and this was because it came during the liberalization and the shift away

from import-substituting industrialization (Lim, 1992). A more recent event was the

Asian Financial Crisis of 1997. Overvaluation was also cited as a major cause (Sta. Ana,

2008). Because the crisis forced the peso to weaken drastically, the problem of

overvaluation lessened after 1997. However, the exchange rate has again become an issue

as the peso again strengthened due to remittances (Bautista, 2003). Sta. Ana III et al

(2008) estimated that peso overvaluation reached almost at 1.5% and have pushed for

depreciating the peso.

Economic theory maintains a strong and close relationship between the exchange

rate and the trade balance. If the sum of import and export elasticities is greater than

unity, or if the Marshall-Lerner condition is fulfilled, then an increase in the exchange

rate will improve the trade balance. This relationship makes the exchange rate an

important tool in trade policy (Dornbusch et al, 2005).

Bahmani et al (2008) identified three distinct ways to investigate the relationship

of the exchange rate and the trade balance. These are to: test for the Marshall-Lerner

condition, J-curve, or S-curve. Testing the Marshall-Lerner condition requires deriving

 3

estimates of trade elasticities. Detecting S-curves on the other hand can be done by

analyzing the cross-correlation function between the trade balance and the terms of trade.

Backus et al (1994) found that the trade balance was negatively correlated with present

and future movements in the terms of trade but positively correlated with the past

movements, evidence of an S-curve. Some studies, including Duldulao (2004) concluded

that the Marshall-Lerner condition may not always apply. Others (Bahmani-Oskooee and

Ratha, 2004) see the Marshall-Lerner condition as a long run result of devaluations and

hypothesize that in the short-run, the trade balance actually deteriorates before it starts to

improve. That is, trade balance adjustment follows a J-curve.

1.2 Significance of the Study

This study shall attempt to clarify some issues regarding exchange rate policy. A

devaluation of the exchange rate is typically used to improve a country’s external

position. However it may also lead to higher prices and cause a contraction in aggregate

demand. Edwards (1985) found that devaluations have a contractionary short-run effect

on output in in Least Developed Countries (LDCs) but also that output expands after one

year. Moreover the Bangko Sentral ng Pilipinas or the BSP traditionally dislikes a

weakening peso since currency appreciation is essential in fighting inflation (Fabella,

2008). Results from the study are hoped to assist the country’s policymakers in

formulating strategies to address the country’s trade deficits and foreign debt. It is also

hoped that the study will provide a reasonable timeframe for estimating the time expected

for reforms to take effect. Knowledge of the dynamics of trade adjustment to exchange
 4

rate changes will also help policymakers deal with and adapt to possible tradeoffs.

Examining the Philippine trade adjustment will also contribute to the debate on the

conflicting goals of government; overvaluing the peso to facilitate debt repayment and

foreign investment versus undervaluing the peso to make local exports more competitive.

The study will also contribute to the local literature by using up to date methods and

models. What few studies done in the country used questionable methods and therefore

can still be improved upon. Most did not check the time-series properties of the variables

and did not take into account the feedback effects that are present in flexible exchange

rate regimes. The study will also avoid aggregation bias and the difficulty of constructing

accurate proxies for world variables by adopting the recent trend of using a bilateral

approach.

1.3 Statement of the Problem

Developing countries like the Philippines face a variety of problems. Persistent

trade deficits in particular, complicate and hamper growth. Devaluation has been a

conventional tool to improve the trade balance. However, this has achieved mixed results.

Major devaluations cited earlier did not lead to an improvement in trade except for the

one that came with liberalization (Lim, 1992).

The study will attempt to answer the following questions: a) does devaluation

actually improve the Philippine trade balance? b) does the trade balance adjustment

follow the pattern described by the J-curve phenomenon?

 5

1.4 Objectives of the Study

The general objective of this study is to determine the path of trade balance

adjustment to changes in the exchange rate. Specifically the study seeks to:

1. describe the trade balance of the Philippines with its top two trading partners

over time; and

2. determine if the J-curve phenomenon applies to the Philippines.

 6

CHAPTER II

REVIEW OF RELATED LITERATURE

2.1 Exchange Rate Changes and the J-curve Phenomenon

Traditional trade models maintain a strong relationship between the trade balance

and the exchange rate. Satisfaction of the Marshall-Lerner condition indicates that a

depreciation improves the trade balance, however this does not take time into account

(Blanchard, 2000). In many cases, depreciation does not improve the trade balance

immediately and may actually worsen it (Bahmani-Oskooee, Ratha 2004). Eventually

the trade balance improves, making the path of adjustment look like a J. Accordingly,

this phenomenon is termed the J-curve phenomenon (Krugman, 2003). Knowledge of this

adjustment process is important for policymakers since they have to consider that they

may have to deal with lower net exports that contract output, at least in the short-run.

Expecting the trade balance to improve instantaneously after a devaluation is unrealistic.

(Blanchard, 2000). This effect on output is especially evident in stabilization programs

conducted in LDCs. Devaluation contracted output by contracting aggregate investments

relative to savings (Morley, 1992). Numerous studies have attempted to empirically

detect and quantify J-curves for several countries using different techniques (Bahmani-

Oskooee, Ratha 2004).

Magee provided a theoretical explanation of the J-curve in 1973. According to

him the J-curve results from contracts in force before devaluation but are completed after
 7

devaluation. The trade balance improves when new contracts that take the new exchange

rate into account begin to dominate the transactions. Junz and Rhomberg (1973)

supplemented Magee’s explanation. They identified five lags that explain the delay in the

adjustment of the trade balance. A recognition lag reflects the time for exporters and

importers to perceive the changed situation. Upon recognition, there is a decision lag in

changing orders of products. Even if this decision lag is short, lags in delivery also slows

adjustment. There may also be a need to use up existing stocks before new orders can be

made. Finally, a production lag exists when producers have to decide how and whether to

reallocate their production. Taken together, Junz and Rhomberg estimate that such

adjustments can take up to five years.

2.2 Empirical Studies on the J-curve Phenomenon using Aggregate Trade Data

These studies were followed by others which then tried to empirically investigate

the effect of devaluation on the trade balance. In 1979, Miles contended that these studies

were lacking in that they: did not determine if trade balance responses were temporary or

permanent, did not compare trade balance levels before and after devaluation, did not

incorporate other variables that may affect trade such as government policy. Miles’

model included differentials between a country and the rest of the world of the following

variables: growth rates, ration of high-powered money to output, ration of government

consumption to output, and the exchange rate. Employing annual data from 14 countries

during the period 1956-1972, Miles concluded that devaluations improved the balance of

payments and the capital account, not the current account. The improvement in the
 8

capital account meant that the effect of devaluation was on portfolio holdings. However,

these results were later disputed. Himarios (1985) pointed out that the real exchange rate

should have been used, not the nominal and that lagged real exchange rate values should

be included. Including these variables, Himarios found that devaluations of the real

exchange rate eventually improve the trade balance.

Bahmani-Oskooee (1985) then introduced a model for detecting J-curves. He

expanded Krueger’s model (1973) and regressed the trade balance on domestic and

foreign income, domestic and foreign levels of high-powered money, and imposed an

Almon lag structure on real exchange rate values divided by the domestic price level

(E/P). With respect to the real exchange rate lags, an initially negative coefficient

followed by a positive coefficient was taken to be indicative of the J-curve phenomenon.

Four LDCs with different exchange rate regimes were examined; Greece, India, Thailand,

and Korea. J-curves were detected in Greece, India and Korea to different extents.

However, Bahmani-Oskooee redefined the real exchange rate variable in 1989. The

reasoning was that since P represents the domestic price level, E should have been

defined as the units of domestic currency per unit of foreign currency, not the other way

around. This revision produced an inverse J-curve for Greece, India and Korea.

Noland (1989) carried out a similar study for Japan. The author estimated

Japanese trade response to relative price changes through a gamma distributed lag model.

The estimates appeared to support a long J-curve for Japan.

A different approach was put forth by Demirden and Pastine (1995). The authors

believed that OLS estimation is an inappropriate technique for examining flexible

exchange rate regimes since exchange rate changes will tend to affect and be affected by
 9

other variables such as income and these “feedback effects” are not reflected in OLS

estimation. Feedback effects are not as significant in fixed exchange rate regimes since

devaluations are done by government, not by the market. As such, Demirden and Pastine

used a VAR model to “endogenize” the variables. Their results suggested that feedback

effects may be important and should be considered in subsequent models.

A more recent study was done by Moura and da Silva (2005) for Brazil. Impulse

response functions were used in an array of models that included Markov-switching and

vector error-correction models. They found that the Marshall-Lerner condition holds for

Brazil while the existence of a Brazilian J-curve was rejected.

2.3 Empirical Studies on the J-curve Phenomenon using Bilateral trade data

So far most of the cited papers used aggregate trade data. Bahmani-Oskooee and

Brooks (1999) suggest that this approach may result in a sort of aggregation bias. That is,

a country’s trade balance and effective exchange rate could be improving with one

country while simultaneously worsening with another. As such, more recent studies use

bilateral data. Employment of bilateral data is also useful because there is no need to

construct a proxy for income of the rest-of-the-world (Rose and Yellen, 1989).

Rose and Yellen pioneered this approach in 1989 (as cited in Bahamni-Oskooee

and Ratha, 2004). The authors employed US quarterly data from the period 1963-1988.

The log-linear model included as explanatory variables US real GNP, real GNP of trade

partner, and the real exchange rate of the US$ with the currency of the trade partner.

Existence of a single unit root for all variables required first differencing to attain
 10

stationarity. Rose and Yellen also tested for co-integration based on the method of Engle

and Granger and used instrumental variables in an attempt to deal with simultaneity bias

among the variables. An application of their model to Germany and Italy yielded negative

findings for the J-curve effect. The authors put this down to possible simultaneity of the

trade balance, exchange rate and output, and the complications arising from the first

differencing procedure.

Marwah and Klein (1996) also conducted a study for US and Canada and their

five largest trading partners using quarterly bilateral data. Instead of defining the trade

balance as the difference between exports and imports, the authors expressed the trade

balance as the ratio of a country’s exports over its imports. Bathmani-Oskooee and Ratha

(2004) suggest that this is advantageous because it makes the trade balance variable unit-

free in addition to allowing a log-linear specification of the model. Marwah and Klein’s

model included as explanatory variables the volume of world trade at constant 1985 US$

prices over GNP of the home country, the real exchange rate of the home country with its

trading partner. Employing the instrumental variable method and imposing a polynomial

distributed lag scheme on the exchange rate, they found evidence for similar J-curves in

both US and Canada.

Another study by Bahmani-Oskooee and Brooks (1999) pointed out flaws in the

two previous studies. With respect to the study of Rose and Yellen (1989), Bahmani-

Oskooee and Brooks assert that defining the trade balance as net exports makes their

findings sensitive to the unit of measurement, and that they should have used error-

correction modeling rather than the Engle-Granger co-integration analysis and the

Augmented Dickey-Fuller Test. Bahmani-Oskooee and Brooks also point out that the
 11

study of Marwah and Klein (1996) suffered from the use of nonstationary data and may

have led to a spurious regression problem. The authors corrected for these and employed

a model similar to that of Rose and Yellen. Instead of the Engle-Granger co-integration

analysis the authors used the error-correction modeling and the Autoregressive

Distributed Lag Approach pioneered by Pesaran and Shin in 1995. The model was used

to examine US bilateral trade relations during the period 1973-1996 with France,

Germany, Italy and Japan, UK, and Canada. In general Bahmani-Oskooee and Brooks

found that dollar depreciation produced mixed short-run trade responses with the six

countries but that in the long run, bilateral US trade balances improved.

Still another study by Bahmani-Oskooee and Wang (2007) employed a more

disaggregated approach, this time focusing on 108 industries in the US and Australia that

engage in trade. The authors used annual data and co-integration analysis on each

industry and found that only in 35 industries was there evidence of a J-curve.

A similar study was done by Bahmani-Oskooee and Ardalani (2007) for 66

industries in the US. Monthly data was used covering the period January, 1991 to

August, 2002. Of the 66 industries, only six (6) exhibit the J-curve effect.

These two studies were the first two studies to employ data at the industrial level

(Bahmani-Oskooee and Ardalani 2007). Thus, these reflect the most recent trend in J-

curve analysis.
 12

2.4 Empirical Studies on the Philippine case

Compared to the wealth of literature in the US situation, relatively few studies

were done on the Philippine trade situation. Dowling (1973) calculated price elasticities

of exports and imports to prove the Marshall-Lerner condition (as cited by Duldulao,

2004). The previously cited study of Miles (1978) also included the Philippines among

the 18 countries examined. With respect to the Philippines, Miles found that devaluation

led to a small improvement in the trade balance after one year.

A number of theses also examined the Philippine trade balance. Cruz (1986)

found exchange rate lags of up to two years are significant in explaining the trade

balance. In particular, the first lagged value is positive while the second is negative. This

means that devaluation only causes a temporary improvement in the Philippine trade

balance, a finding contrary to the J-curve. Cruz interpreted this to mean that the

Philippine trade balance follows a more monetary approach.

Lansigan and Lopez (1991) on the other hand employed a variant of Bahmani-

Oskooee’s 1985 model to detect a J-curve for the Philippines. The authors regressed the

trade balance on real foreign and domestic income, real foreign and domestic high-

powered money, real domestic government expenditures, and the real effective exchange

rate. Lagged values of real domestic and world income, and real domestic high-powered

money were found to negatively affect the trade balance while the real effective exchange

rate was found to improve the trade balance.

Duldulao (2004) pointed out that these studies did not take the time-series

properties, in particular stationarity, of the variables into account. Using data from 1989-
 13

2004, Duldulao estimated a double logarithmic equation that included as explanatory

variables real domestic and foreign income, contemporaneous real effective exchange

rate, real and foreign high-powered money, and domestic government expenditure. The

author also followed Bahmani-Oskooee in defining trade balance as the ratio of exports

to imports. Duldulao determined that only real domestic and foreign income and real

domestic high-powered money significantly affect the trade balance. The author also

tested for the Mashall-Lerner condition which was then found not to apply to the

Philippine setting.
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CHAPTER III

THEORETICAL FRAMEWORK

Since exchange rate policy is a major option for countries facing persistent trade

deficits, it is important to understand the relationship between the trade balance and

exchange rate. In this regard, there are three approaches which are used to explain the

relationship. These are the elasticities, absoption and monetary approaches.

The elasticities approach assumes that the increases in the nominal exchange rate,

improves the trade balance through a relative price effect. An increase in the exchange

rate makes imports more expensive and exports cheaper, discouraging consumption of

imports and encouraging production of exports. This holds true when the sum of export

and import demand elasticities exceed unity, or when the Marshall-Lerner condition is

satisfied for the country (Krugman, 2003). This approach is closely related with a

Keynesian framework and the improvement in the trade balance is also accompanied by

an expansion in aggregate output and employment (Cruz, 1986).

Proponents of the absorption approach (Alexander, 1952) assume that exchange

rate increases improve the trade balance through expenditure-switching and expenditure

reducing policies. In general, the trade balance improves if domestic production exceeds

domestic absorption. Devaluations facilitate this in two ways. The first is when

devaluations, through a process similar to the elasticities approach, push domestic and

foreign expenditures toward domestic goods. The second is when devaluations are

implemented in an economy that is already at full employment. Devaluation makes

exports relatively cheaper and the resulting excess demand produces inflation. Inflation
 15

effectively reduces real balances which in turn may decrease demand for goods (Cruz,

1986).

In contrast to the two approaches, the monetary approach argues that increases in

the exchange rate only cause a temporary improvement in the balance of payments

(Dornbusch et al, 2005). The temporary improvement is due to an increase in the

competitiveness of the country’s exports. However, this leads to a rise in money stock

which will in time increase aggregate demand and therefore prices. Once money supply

and prices rise enough to counter the short-run relative price effect of the exchange rate

increase, the improvement brought about by the depreciation will be exhausted.

Even if exchange rate policy does impact the trade balance, empirical studies

cited earlier (Bahmani-Oskooee and Ratha, 2004) have shown that the effects may be

delayed over a time period. Depreciation may initially worsen the trade balance before

improving it in the long-run as depicted in Figure 1. In a way this interprets the

Marshall-Lerner condition as a long-run condition (Bahmani-Oskooee and Brooks,

1999). The exchange rate increase temporarily makes exports cheaper and imports more

expensive, so if adjustment is slow then export receipts will be lower while import

payments will be higher. Eventually as adjustment goes on the trade balance will

improve. This pattern of trade balance adjustment is termed the J-curve phenomenon.
 16

Figure 3.1. The J-curve

Source: Macroeconomics (Blanchard, 2000)

Figure 1 illustrates the process. Starting with a deficit of OA, a depreciation

increases the deficit to OB because export earnings have become smaller while import

payments became larger. Over time exports and imports adjust and net exports equal its

original level at point C before settling at a higher level above C.

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CHAPTER IV

METHODOLOGY

4.1 Model and Variables

This study used a bilateral approach to reflect recent trends in the literature. In

particular, the study focused on the top two trading partners of the Philippines, the United

States and Japan. To integrate the three approaches enumerated earlier, the trade balance

was specified as a function of real domestic income, real foreign income, domestic

government expenditure, real domestic high-powered money, real foreign high powered

money and the real effective exchange rate. The general form of the trade balance

equation can be expressed as

TB = f(YD, YW, GOV, MD, MW, REER),

where TB is the trade balance, YD is real domestic income, YW is real foreign income,

GOV is domestic government expenditure, MD is domestic money supply, MW is

foreign money supply, and RER is the real bilateral exchange rate.

TB is defined as the ratio of exports to imports. As mentioned earlier, this has the

advantage of making the trade balance variable unit-free and can be interpreted as either

the real or nominal trade balance (Bahmani-Oskooee and Brooks, 1999).

YD is defined as real gross national product of the Philippines. Its expected effect

on the trade balance is negative because a rise in national income increases demand for

imports leading to a deterioration of the trade balance. It can also be positive however. As

Magee (1973) argued, domestic production of importables can also rise faster than the
 18

rise in domestic consumption of these such that the net effect will be a decrease in

imports.

YF is defined as real income of trading partner. It is expected to be positively

related with the trade balance. An increase in world income increases demand for

exports, improving the trade balance. However, as argued again by Magee (1973), the

effect can also be negative.

GOV is defined as the level of real domestic government expenditures. An

increase in government expenditures will increase aggregate demand or absorption. This

may deteriorate the trade balance therefore the expected effect is negative (Blanchard,

2001).

MD is defined as the level of domestic money. . An increase in the domestic

money supply raises the public’s demand for goods and services. As individuals perceive

their wealth to their expenditures will increase compared to income, the trade balance

would eventually worsen. However, Miles (1979) also gave reasons that may cause the

effect on the trade balance to be positive. For one, nominal money balances may only be

a small portion of wealth. Money might not also be seen as net wealth by the private

sector. Even if it is, the resulting increase in expenditures may be too small so as not to

affect the trade balance.

MF is defined as the level of trading partner money. The expected effect of this is

opposite of that of MD. Again, for reasons outlined above, the effect may also be

negative.

RER is the real bilateral exchange rate of the Philippines with the trading partner.

The impact of changes in the ER is indefinite. All things held constant, a depreciation
 19

makes exports cheaper such that demand for them expands and improves the trade

balance. However, the depreciation also makes imports relatively more expensive so if

adjustment in the quantity of imports is sluggish, the trade balance may deteriorate in the

short-run. Evidence of a j-curve would be indicated by initially negative coefficients

followed by positive coefficients.

4.2 Analytic Procedure

The analysis tried to improve on existing literature by using up to date techniques.

Previous studies (Cruz, 1986 and Lansigan, 1991) on detecting a J-curve for the

Philippines did not attempt to verify if their time series were stationary or that there

might exist a long-run relationship between the variables. Duldulao (2004) tested the

relationship of the trade balance with the contemporaneous value of the real exchange

rate and not on its past values.

The procedure followed four stages. Unit root tests were done on each of the

variables. A series of vector autoregressions were then estimated to determine the

appropriate lag length on the basis of several information criteria. Johansen’s test was

then used to check for co-integration. If the test suggests a co-integrating relationship, a

vector error correction model was estimated. If the variables do not co-integrate, then the

nonstationary variables were differenced and then applied together with the stationary

variables (if any) in a vector autoregression model. In order to aid in the interpretation of

the model, impulse response functions will be used to examine the effect of shocks on the

trade balance.
 20

4.3 Unit Root Test

Regression analysis assumes that the data are stationary or that its mean, variance,

and autocovariances do not vary with time. Ignoring these assumptions in a time series

analysis exposes one to the problem of spurious regression. However, most time series

data are in fact nonstationary. High R2 and t-ratios that may lead to the conclusion that

there is a relationship between variables when there should not be any. Also, each set of

time series data from a specific period cannot be generalized to other time periods

(Gujarati, 2003).

Most macroeconomic time series data exhibit nonstationarity, hence detecting and

dealing with it should be done before estimation. Nonstationary time series can only be

studied for the time period under consideration and its behavior cannot be generalized

into other time periods. Such time series also have a variance that tends toward infinity

since the entire value, including the error term, is carried over from the previous period to

the next.

A formal test for determining stationarity is to look for unit roots using the

Augmented Dickey Fuller or the ADF test. The test involves estimating a regression such

as:

m
Yt = 1 +  2 t +  Yt −1 +   i Yt −i +  t ,
i =1
 21

where Yt is the variable of interest in first difference, and lagged difference

 m 
terms    t  Yt −i  are to be included to ensure that the error term 𝜀𝑡 is serially
 i =1 

uncorrelated. The null hypothesis (H0) is δ=0 or that the time series is nonstationary. This

is tested against the alternative hypothesis (H1) is δ≠0 or that the time series is stationary.

If the calculated tau statistic is smaller (i.e., more negative) than the critical value, then

H0 is rejected and the series is deemed to be stationary or I(0). If on the other hand the

calculated statistic is larger than the critical value, then H0 can be accepted and the time

series is nonstationary or that it contains a unit root. First differences taken from variables

found to be nonstationary in levels were again subjected to the ADF test to determine if

the variable is integrated of order one or I(1).

4.4 Lag Length Selection

Choosing the optimum lag length for the tests is important since too few lags may

lead to omission of relevant variables while too many lags may reduce efficiency and

degrees of freedom (Gujarati, 2003). Model selection criteria such as the Akaike (AIC),

Schwarz (BIC) and Hannan-Quinn (HQC) criteria will be the basis for selecting the

appropriate lag length. The model with the lowest value of the information criteria will be

used. If each criterion suggest differing lag lengths, Johansen et al (2000) state that the

HQ criterion is to be preferred.
 22

4.5 Co-integration Test

A test for co-integration is used to verify the existence of a stable long-run

equilibrium relationship between variables. Also, as noted by Granger (1986), co-

integration “can be thought of as a pre-test to avoid spurious regression situations” since

co-integration entails testing the error term for stationarity. However, this study made use

of Johansen’s co-integration test since there are multiple variables involved and there

may be more than one co-integrating relationship (Harris and Sollis, 2003). The Johansen

approach is based on the vector autoregression (VAR) approach (Greene, 2003). Defining

zt as the vector of the endogenous variables [TB RER YD MD GOV] in the model and k

as the lag length, an error-correction representation of the VAR may be written as:

Δzt = Γ1 Δzt-1 + . . . + Γt-k+1Δzt-k+1 + Пzt-1 + ut

П is an n x n matrix that contains information on long-run relationships since it is

also equal to αβ’ where α denotes speed of adjustment while β is a matrix of long-run

coefficients. An expanded form of this equation is presented in Appendix 1.

Determining co-integration rank is equivalent to testing how many linearly

independent columns there are in П. If П has full rank then all variables in z are

stationary and the appropriate model is a VAR in levels while if П has zero rank then

there are no co-integration relationships and the appropriate model is a VAR in first

differences (Harris and Sollis, 2003). If П has reduced rank then there are r < (n-1) co-

integration vectors. The Johansen approach makes use of two tests to determine co-

integration rank, the trace test and the Lmax test, although the trace test is to be preferred.
 23

The null hypothesis is that there are at most r co-integration vectors versus the alternative

hypothesis that there are r +1 co-integration vectors. If the trace statistic is greater than

its critical value then the null hypothesis will be rejected. The co-integration rank will be

the rank at which the null hypothesis is accepted.

4.6 Vector Autoregression

Variables have to be integrated of the same order to procede with co-integration

analysis. If they are not co-integrated then nonstationary variables will be differenced and

a VAR model will be estimated containing the transformed and the stationary variables.

The general form of the vector autoregression with constant if all variables are stationary

is:

zt = A0 + A1zt-1+ …+ Akzt-k + ut

where zt – is a (n x 1) vector of stationary endogenous variables: TB, RER, YD,

MD and GOV, A0 is a (n x 1) vector of intercept terms, Ai– is a (n x 1) ith matrix of

coefficients εt – is a (n x 1) vector of error terms that may be contemporaneously

correlated, but are uncorrelated with their own lagged values and uncorrelated with all of

variables in the right-hand side. The expanded form of the model is presented in

Appendix 2.

Impulse response functions will be used to observe the effects of shocks of the

real exchange rate variable on the bilateral trade balance. Impulse response functions

were used to observe the response of the bilateral trade balance to shocks in the real
 24

bilateral exchange rate (Gujarati, 2003). Use of the IRF will show whether the plot of

forecast values of the bilateral trade balance in response to a shock in the bilateral

exchange rate follow a J-curve pattern. The expanded form of the model is presented in

Appendix 2.

4.7 Vector Error Correction

Co-integration among variables means that there is a long-run relationship among

them. If one variable is above the level suggested by another variable with which it is co-

integrated, then the former can be expected to decrease in the next period. Thus

deviations away from the equilibrium relationship could be included as an explanatory

variable as an error correction term (Salvatore and Reagle, 2002). Bahmani-Oskooee and

Brooks (1999) also contend that error-correction modeling can be a way of detecting the

J-curve effect since it incorporates short and long-run dynamics of the trade balance into

one model. A vector error correction model can help in the detection of J-curves through

the signs of the short-run coefficients as well as the value and significance of the error-

correction term. A J-curve may be indicated by initially negative coefficients of the

exchange rate variable followed by positive ones. The impulse response of the trade

balance to the real exchange rate will also be plotted to determine whether the response

of the bilateral trade balance to a shock in the bilateral exchange rate follows a J-curve

pattern.
 25

4.8 Sources of Data

The study used quarterly data from the first quarter of 1985 up to the fourth

quarter of 2007 and obtained a sample size of 92 observations. The data used were

quarterly, from 1985-2007. This period was chosen to include only the data from the

flexible exchange rate regime. Most data were gathered from the International Financial

Statistics (IFS) and Direction of Trade Statistics published by the International Monetary

Fund. Transformations were also done in order to ensure uniform units of measurement.

The exchange rate data expressed in national currency over US $ were

transformed to be Php over national currency of trading partner. The real bilateral

exchange rate with trading partner was then calculated as follows:

RER = NER*CPItrading partner/CPIRP

Other nominal data were converted into real terms using real terms using the

consumer price index (2000=100) and were converted into dollars such that the dataset

was composed of real data in billion US dollars. The resulting datasets for the

Philippines-US and Philippines-Japan models are shown in Appendix 3 and Appendix 4,

respectively.
 26

CHAPTER V

RESULTS AND DISCUSSION

This section is divided into four parts. It begins by discussing the trends in the

bilateral trade balance and bilateral exchange rate data were. It then presents the results of

the tests for nonstationarity using the Augmented Dickey-Fuller test. The lag lengths used

in the ADF test were determined by maximizing adjusted R2. Nonstationary variables

were transformed and then tested again to ensure that the transformed data were now

stationary. This also helped in identifying the order of integration. Third, the optimum lag

lengths for the Philippines-US and the Philippines-Japan models were selected based on

the Hannan-Quinn Criterion (HQC). Fourth, the models were tested for co-integration. A

vector autoregression was estimated in the model with no co-integration while a vector

error-correction model was estimated in the model with co-integration. In both cases

impulse response functions were plotted to trace over time the expected responses of the

trade balance to a shock in the bilateral exchange rate.

5.1 Trend Analysis

Ratio of Philippine exports to imports with the United States averaged 1.26 for the

period 1985-2007. This means that for the period, exports to the US have been on

average, 1.26 times larger than imports from the US. The highest export to import ratio of

2.09 occurred in 2001 with exports twice the amount of imports. The next three highest

export to import ratio occurred in 1999, 2000, and 2002, making that period a relatively
 27

good one for Philippine bilateral trade with the US. However, recent performance has

been worse. The lowest trade ratio in the period was recorded in 2004 with exports just

70.45% of imports. For the last five years the trade ratio has been very close to unity.

On the other hand, Philippine trade with Japan averaged 0.76. This means that for

the period 1985 to 2007, exports to Japan averaged only 76% of imports from Japan.

While exports were 1.31 times larger than imports at the start of the period, the ratio of

exports to imports steadily declined until it reached its lowest point of 0.33 in 1994. Since

then it has risen and reached balance in 2004. From 2004 onwards the ratio of Philippine

exports to imports with Japan has swung between .80 and 1.2 while averaging 1.03.

Philippines-US Exports/Imports
2.5
2
1.5
1
0.5
0
Q1 1985
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990
Q1 1991
Q1 1992
Q1 1993
Q1 1994
Q1 1995
Q1 1996
Q1 1997
Q1 1998
Q1 1999
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007

Figure 5.1.1. Philippines-US Exports/Imports

Source: Author’s computations based from the Direction of Trade Statistics data
 28

Philippines-Japan Exports/Imports
1.4
1.2
1
0.8
0.6
0.4
0.2
0
Q2 1987

Q3 2001

Q2 2005
Q1 1985
Q4 1985
Q3 1986

Q1 1988
Q4 1988
Q3 1989
Q2 1990
Q1 1991
Q4 1991
Q3 1992
Q2 1993
Q1 1994
Q4 1994
Q3 1995
Q2 1996
Q1 1997
Q4 1997
Q3 1998
Q2 1999
Q1 2000
Q4 2000

Q2 2002
Q1 2003
Q4 2003
Q3 2004

Q1 2006
Q4 2006
Q3 2007
Figure 5.1.2 Philippines-Japan Exports/Imports
Source: Author’s computations based from the Direction of Trade Statistics data

For the period under consideration, the real bilateral exchange rate with the US

averaged 40.37 pesos to a dollar. The maximum of 52.21 pesos to a dollar occurred in

2004 while the minimum of 28.99 occurred in 1997. The real bilateral exchange rate was

around 40 pesos per dollar until the early 1990’s. This was followed by an appreciation of

the real exchange rate. Following the 1997 crisis the bilateral exchange exhibited an

upward trend before appreciating again in recent years.

In contrast with the relatively high exchange rate with the US, the real bilateral

exchange rate with Japan averaged only 0.35 peso to one yen. The lowest value of 0.19

occurred in 1985, which is also the start of the period. On the other hand, the maximum

of 0.45 occurred in 2004, which is towards the end of the period. The maximum of 0.45

achieved at the same time as bilateral trade balance.

 29

Real bilateral exchange rate P/$

60

50

40

30

20

10

Q1 2003

Q1 2006
Q1 1985
Q4 1985
Q3 1986
Q2 1987
Q1 1988
Q4 1988
Q3 1989
Q2 1990
Q1 1991
Q4 1991
Q3 1992
Q2 1993
Q1 1994
Q4 1994
Q3 1995
Q2 1996
Q1 1997
Q4 1997
Q3 1998
Q2 1999
Q1 2000
Q4 2000
Q3 2001
Q2 2002

Q4 2003
Q3 2004
Q2 2005

Q4 2006
Q3 2007
Figure 5.1.3 Real bilateral exchange rate defined as peso over dollar
Source: International Financial Statistics

Real bilateral exchange rate P/Y

0.5
0.45
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Q1 1985
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990
Q1 1991
Q1 1992
Q1 1993
Q1 1994
Q1 1995
Q1 1996
Q1 1997
Q1 1998
Q1 1999
Q1 2000
Q1 2001

Figure 5.1.4 Real bilateral exchange rate defined as peso over yen
Source: International Financial Statistics

This study therefore presents two contrasting cases. As shown in Figures 5.1.1

and 5.1.3, the Philippine trade situation with the US has been characterized by

comparatively high peso-dollar exchange rates and trade surpluses. On the other hand,
 30

Figures 5.1.2 and 5.1.4 show in trade with Japan, the Philippines has had generally low

peso to yen exchange rates and chronic deficits. The summary statistics and the graphs of

the other variables are presented in the Appendix 5. Most of these variables seem to

exhibit seasonality.

5.2 Unit Root Testing

The ADF test was carried out on all variables in levels. For each variable, the lag

length that led to the highest R2 was chosen. If the variables were found to be

nonstationary, their first differences were also tested. Stationary first differences mean

that the nonstationary variables are integrated of order 1 or I(1). The results of the tests

are summarized in Table 5.2

Table 5.2. Augmented Dickey-Fuller test

Variable Tau Tau stat (in First Order of
stat (in Lags Lags Differences) integration
levels)1
TBRP-US -3.90 2 NA NA I(0)
RER (P/$) -1.74 3 5 -4.44 I(1)
YD -1.05 5 5 -4.74 I(1)
GOV -3.21 4 4 -3.99 I(1)
MD -1.38 5 4 -5.02 I(1)
YWUS -2.03 2 1 -4.70 I(1)
MWUS -2.45 5 0 -7.86 I(1)
RER (P/Y) -2.85 4 1 -8.45 I(1)
TBRP-JAPAN -2.16 3 2 -7.57 I(1)
MWJAPAN -2.14 3 2 -3.69 I(1)
YWJAPAN -2.85 3 2 -4.62 I(1)

1
The critical value at the 5 percent level of significance is -3.41.
 31

All variables except Philippines-US trade ratio were found to be nonstationary at

the 5% level of significance. Their first differences were also tested and these were found

to be stationary, indicating that they are integrated of order 1. . However, the result that

Philippines-US trade ratio is already stationary or I(0) means that it cannot be co-

integrated with the other variables of the model.. The Philippines-US model will then be

estimated by a VAR with the Philippines-US trade ratio in levels while the other

variables are in first differences. On the other hand, all the Philippines-Japan variables

are integrated of the same order so it is still possible for co-integration in that model to

exist.

5.3 Lag length selection

Various criteria were used to help in choosing the lag lengths. The two criteria

presented in Table 5.3 are the Schwarz/Bayesian Information Criterion (BIC) and the

Hannan-Quinn criterion (HQC). The optimal lag length is the one that minimizes the

criteria. For the Philippines-US model, the two criteria suggest an optimum lag length of

three (3) periods. However, for the Philippines-Japan model, the two criteria suggest

different lag lengths. The BIC suggests a one period lag and while the HQC recommends

a lag of three periods. In such a situation, Harris (2003) cited that the common practice is

to follow the HQC. In any case, it is less dangerous to include excessive lags than

insufficient lags. Given the findings above, both models will be estimated with three lags.
 32

Table 5.3 Optimum lag length selection based on SIC and HQC
Philippines- Philippines-
US Japan

Lags SIC HQC lags SIC HQC

1 -26.47 -27.17 1 -36.43 -37.13
2 -26.38 -27.51 2 -35.75 -36.88
3 -26.95 -28.52 3 -36.19 -37.76
4 -26.45 28.46 4 -35.65 -37.65
5 -25.73 -28.17 5 -34.93 -37.37
6 -25.34 -28.22 6 -34.00 -36.88
7 -24.68 -28.00 7 -33.16 -36.47
8 -23.95 -27.70 8 -32.61 -36.36

5.4 VAR estimation of the Philippines-US model

The VAR for the Philippines-US model contained a mix of variables in levels and

first differences. Following the results of the ADF tests, the trade balance was expressed

in levels while the other variables were expressed in first differences. US money and

GDP entered the model as exogenous variables because there is no reason to expect that

Philippine policy can affect them. The relevant equation is presented in Table 5.4 and the

entire VAR output is presented in Appendix 6. The results indicate that many of the

estimated coefficients are not individually statistically significant on the basis of the t-

test. This is possibly due to multicollinearity arising from the inclusion of so many lags in

the equation system. However, the equation for the trade balance as whole is statistically

significant because the F-statistic 7.319442 is greater than the critical value at the 5%

level of significance.
 33

Table 5.4. VAR estimation of the Philippines-US model

Variable Coefficient t-statistic

constant 0.13 1.05

ΔGOVt-1 -683 -0.82

ΔGOVt-2 803 1.27

ΔGOVt-3 -1073 -1.36

∆RER t-1 -0.0064 -0.52

∆RER t-2 -0.014 -0.95

∆RER t-3 -0.0018 -0.13

ΔMDt-1 -1.49 -0.23

ΔMDt-2 3.092 0.47

ΔMDt-3 -0.58 -0.11

ΔTBt-1 0.65 5.59

ΔTBt-2 -0.11 -0.76

ΔTBt-3 0.33 2.75

ΔYDt-1 -1.10 -0.55

ΔYDt-2 -4.71 -2.45

ΔYDt-3 1.90 0.97

YW 0.041 0.91

MW -0.043 -0.51
 34

5.5 Impulse Response of Philippines-US trade balance

Since the coefficients in Table 5.4 are difficult to interpret, the impulse response

of the trade balance to a shock in the bilateral exchange rate was plotted. Figure 5.5 is

shown here because it was difficult to determine the magnitude of the impulse responses.

The impulse responses shown here are responses to Cholesky one standard deviation

innovation forecasted over forty periods or ten (10) years.

Figure 5.5 Impulse response of Philippines-US trade to Cholesky one s.d.

shock in ∆RER

Despite the evident seasonality, Figure 5.5 shows a clear J-curve pattern.

Following the shock, the trade balance initially worsens for two periods before beginning

to improve. From the third until the thirtieth quarters, the depreciation shock improves

the trade balance. The shock eventually results in a bigger improvement than the initial

deterioration with the peak arriving seven periods after the shock. The path to
 35

improvement is three periods longer than what Miles (1978) found, but both findings

seem to support evidence for a J-curve. The following periods then show a gradual

dissipation of the effect of the exchange rate shock. The effect of the shock was

temporary since the response converged to zero.

5.6 Co-integration analysis of Philippines-Japan model

The analysis for the Philippines and Japan will attempt to look into possible long-

run relationships because all the variables are integrated of order one. Since there are

greater than two variables involved, co-integration will be tested for using the Johansen

approach. As in the previous model, Japan money and GDP were treated as exogenous. A

model with “unrestricted constant” and “restricted trend” was adopted since the data in

levels seemed to exhibit trends while their first differences did not2. The trace and max-

eigenvalue tests were carried out to determine the number of co-integrating equations.

The two tests to determine the co-integration rank of the Philippines-Japan system

both suggest the existence of one co-integrating equation at the 0.05 level of significance,

as shown in Table 5.6.1. The null hypothesis of no co-integration was rejected while the

null hypothesis that there is at most one co-integrating equation was accepted by both

tests. Since the Johansen tests indicate the existence of a long-run relationship, a vector

2
There are five possible cases as shown by Johansen (1995) and cited by Cottrell (2008). These are: Case
1 – no constant, Case 2 - restricted constant, Case 3 – unrestricted constant, Case 4 - constant + restricted
trend, Case 5 - constant + unrestricted trend. Cottrell summarized the criteria for choosing among the cases.
If the variables exhibit a linear trend then the constant should not be restricted and Case 3 is used. Also if
taking first differences eliminates the linear trend then Case 4, unrestricted constant and restricted trend, is
chosen.
 36

error-correction model with three lags and co-integration rank 1 was estimated. Again,

Japan money and GDP were treated as exogenous. The relevant equation from the vector

error correction model is in Table 5.6.2 and the entire output is presented in Appendix 7.

Table 5.6.1 Johansen Co-integration test

Restricted trend, unrestricted constant
Lag order = 3

Hypothesized Trace
No. of CE(s) Eigenvalue Statistic Prob.**

None * 0.60110 136.153 0.0000

At most 1 * 0.26609 56.488 0.1790
At most 2 0.17758 28.954 0.5699
At most 3 0.11585 11.554 0.8383
At most 4 0.006676 0.5962 0.9991

Trace test indicates one co-integrating equation at the 0.05 level

Hypothesized Max-Eigen
No. of CE(s) Eigenvalue Statistic Prob.**

None * 0.60110 81.79 0.0001

At most 1 * 0.26609 27.534 0.1681
At most 2 0.17758 17.400 0.4396
At most 3 0.11585 10.958 0.5292
At most 4 0.006676 0.59617 0.9991

Max-eigenvalue test indicates one co-integrating equation at the 0.05 level

 37

Table 5.6.2 Vector error-correction model with three lags

Case 4: Restricted trend, unrestricted constant

VARIABLE COEFFICIENT P-VALUE

Const 0.27 0.43

ΔYDt-1 2.19 0.16

ΔYDt-2 0.73 0.50

ΔGOVt-1 -413 0.31

ΔGOVt-1 232 0.55

ΔTBt-1 -0.28 0.02

ΔTBt-2 -0.17 0.16

ΔRERt-1 0.22 0.63

ΔRERt-1 -0.07 0.87

ΔMDt-1 -2.21 0.54

ΔMDt-2 -4.32 0.19

MWJAPAN 0.0046 0.25

YWJAPAN 0.0043 0.20

EC -1.98 0.30

The model has a noticeably lower R2 than the Philippines-US model. Many of the

lagged variables are also statistically insignificant, possibly due to multicollinearity. The

insignificance of the error term however, suggests that the trade balance adjusts to

equilibrium in the same period.

 38

5.7 Impulse response of Philippines-Japan trade balance

Figure 5.7. Impulse response of Philippines-Japan trade to Cholesky one s.d.

shock in RER.

An impulse response function is again used here to capture short run dynamics of

the trade balance response to the peso-yen exchange rate. The response of Philippines-

Japan trade was forecasted over twenty periods, or five years. Figure 5.7 showed an

unusual result, the shock in the real bilateral exchange rate worsened the trade balance for

three quarters before improving to above one in the fifth quarter. It then declines again to

another low in the seventh quarter and the settles at around -.0025. Figure 5.7 seems to

follow a J-curve pattern but it does not in the end result in a net improvement of the

Philippines-Japan trade balance. In fact, the graph seems to suggest that a shock in the

real exchange rate permanently worsens the Philippines-Japan trade balance by -.0025

every quarter. This conforms with the finding by Duldulao (2004) that the Marshall-

Lerner condition may not apply in the Philippine context.

 39

CHAPTER VI

SUMMARY AND CONCLUSION

This study sought to identify the key economic variables affecting the Philippine

trade balance from 1985 to 2007. The period chosen represented the flexible exchange

rate regime. Specifically this study aimed to determine the effect of each variable on the

Philippine trade balance and to determine if the J-curve phenomenon applies to the

Philippines. A bilateral approach focusing on the country’s top two trading partners, the

United States and Japan, was adopted in order to avoid aggregation bias and the difficulty

of constructing an accurate proxy for world variables. This move also reflected the recent

trend of bilateral studies on a problem that had earlier been addressed by aggregate

models. Graphical analysis showed that the Philippines has usually had trade surpluses

with the US until recent years while having chronic trade deficits with Japan. After

gathering and transforming the data to make them uniform in measurement, four steps of

analysis followed; unit root testing, lag length selection, vector autoregression or co-

integration analysis, and estimation of the impulse response functions. Unit root tests

were done to determine the order of integration of the variables. Contingent on their

outcome, Johansen’s co-integration test was done to test for a long-run relationship

among the variables. Non-existence of a co-integration relationship means that the model

to be adopted would be a VAR with nonstationary variables taken first differences.

Existence of a co-integration relationship necessitates the use of a VECM. In both cases

impulse response functions were plotted to better illustrate the dynamics of trade balance

response to shocks in other variables.

 40

After summarizing the trends of the bilateral trade balances and exchange rates,

the Augmented Dickey-Fuller test was carried out on all the variables. All but one of the

variables were found to be nonstationary in levels so a second test was done on their first

differences. Their first differences were found to be stationary so it was concluded that all

these variables were integrated of order one while the Philippines-US trade balance was

the only stationary variable in levels. The finding that Philippines-US trade balance is

already stationary in levels meant that analysis of the Philippines-US model would

immediately proceed to VAR. The other variables were differenced once to make them

stationary and the US GDP and money variables were taken as exogenous. A plot of the

impulse response of the Philippines-US trade balance to shock in the peso was shown.

The response of the trade balance to a shock in the exchange rate followed the J-curve

pattern reinforcing the findings of Miles (1978). Meanwhile, the Philippines-Japan

variables were tested for co-integration. Both the trace test and the max-eigenvalue test

found the existence of one co-integrating relationship so a VEC was estimated with

cointegration rank 1. The impulse response of the Philippines-Japan trade balance was

also plotted. A seemingly J-curve pattern was also observed in the response of the trade

balance to the exchange rate but the end effect was still negative, similar to what was

found by Duldulao (2004). Thus this study provides mixed results for the J-curve

phenomenon.
 41

CHAPTER VII

LIMITATIONS OF THE STUDY

This study was limited to only the top two trading partners of the Philippines, the

United States and Japan. This is due to unavailability of data for some of the other large

trading partners. Most bilateral studies on the J-curve effect study five or more countries

but this option was not available in this study. Also, the methods used in the study are

typically used for annual data and might not be less than ideal for data that exhibit

seasonality. However, this was not tested for due to the complexity of the methods

involved. Future studies may expand the analysis to other trading partners, include more

variables, and/or use methods that can correct seasonality.

 42

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 44

APPENDIX
 45

Appendix 1. Expanded version of the error-correction representation of the VAR, as applied to the current model

TBt =  1,1TBt −1 + ... +  1, k TBt − k +  1,k +1RERt −1 + ... +  1,2 k RERt − k +  1,2 k +1YDt −1 + ... +  1,3 k YDt −k +  1,3 k +1MDt −1 + ... +  1,4 k YDt −k
+ 1,4 k +1GOVt −1 + ... +  1,5 k GOVt − k + 1 ( 11TBt −1 − 12 RER − 13YD − 14 MD − 15GOV ) + u1t

RERt =  2,1TBt −1 + ... +  2, k TBt − k +  2, k +1RERt −1 + ... +  2,2 k RERt − k +  2,2 k +1YDt −1 + ... +  2,3 k YDt − k +  2,3 k +1MDt −1 + ... +  2,4 k YDt −k
+ 1,4 k +1GOVt −1 + ... +  2,5 k GOVt − k +  2 (  21TBt −1 −  22 RER −  23YD −  24 MD −  25GOV ) + u2t

YDt =  3,1TBt −1 + ... +  3,k TBt − k +  3,k +1RERt −1 + ... +  3,2 k RERt −k +  3,2 k +1YDt −1 + ... +  3,3 k YDt −k +  3,3 k +1MDt −1 + ... +  3,4 k YDt −k
+ 3,4 k +1GOVt −1 + ... +  3,5 k GOVt − k +  3 ( 31TBt −1 − 32 RER − 33YD − 34 MD − 35GOV ) + u3t

MDt =  4,1TBt −1 + ... +  4,k TBt − k +  4, k +1RERt −1 + ... +  4,2 k RERt − k +  4,2 k +1YDt −1 + ... +  4,3 k YDt − k +  4,3 k +1MDt −1 + ... +  4,4 k YDt −k
+ 4,4 k +1GOVt −1 + ... +  4,5 k GOVt − k +  4 (  41TBt −1 −  42 RER −  43YD −  44 MD −  45GOV ) + u4t

GOVt =  5,1TBt −1 + ... +  5,k TBt − k +  5,k +1RERt −1 + ... +  5,2 k RERt − k +  5,2 k +1YDt −1 + ... +  5,3 k YDt − k +  5,3 k +1MDt −1 + ... +  5,4 k YDt −k
+ 5,4 k +1GOVt −1 + ... +  5,5 k GOVt − k +  5 ( 51TBt −1 − 52 RER − 53YD − 54 MD − 55GOV ) + u5t

where:  ii = 1 for i = 1,...,5

 46

Appendix 2. Expanded version of the VAR, as applied to the current model

TBt = a1,0 + a1,1TBt −1 + ... + a1,k TBt − k + a1, k +1 RERt −1 + ... + a1,2 k RERt −k + a1,2 k +1YDt −1 + ... + a1,3k YDt −k + a1,3k +1 MDt −1 + ... + a1,4 k MDt −k
+ a1,4 k +1GOVt −1 + ... + a1,5 k GOVt − k + u1t

RERt = a2,0 + a2,1TBt −1 + ... + a2,k TBt − k + a2,k +1 RERt −1 + ... + a2,2 k RERt − k + a2,2 k +1YDt −1 + ... + a2,3k YDt −k + a2,3 k +1 MDt −1 + ... + a2,4 k MDt −k
+ a2,4 k +1GOVt −1 + ... + a2,5 k GOVt − k + u2t

YDt = a3,0 + a3,1TBt −1 + ... + a3,k TBt − k + a3, k +1 RERt −1 + ... + a3,2 k RERt −k + a3,2 k +1YDt −1 + ... + a3,3k YDt −k + a3,3k +1 MDt −1 + ... + a3,4 k MDt − k
+ a3,4 k +1GOVt −1 + ... + a3,5 k GOVt − k + u3t

MDt = a4,0 + a4,1TBt −1 + ... + a4,k TBt − k + a4,k +1 RERt −1 + ... + a4,2 k RERt −k + a4,2 k +1YDt −1 + ... + a4,3k YDt −k + a4,3 k +1 MDt −1 + ... + a4,4 k MDt −k
+ a4,4 k +1GOVt −1 + ... + a4,5 k GOVt − k + u4t

GOVt = a5,0 + a5,1TBt −1 + ... + a5, k TBt − k + a5, k +1 RERt −1 + ... + a5,2 k RERt −k + a5,2 k +1YDt −1 + ... + a5,3 k YDt −k + a5,3 k +1 MDt −1 + ... + a5,4 k MDt −k
+ a5,4 k +1GOVt −1 + ... + a5,5 k GOVt − k + u5t
 47

Appendix 3. Philippines-US dataset

QUARTER TBRP-US RER (P/$) YD MWUS GOV MD YWUS

Q1 1985 1.156532 35.393123 0.255861 9.693429 0.000527 0.048374 59.569662
Q2 1985 1.151474 35.679808 0.264675 9.885499 0.000531 0.049148 60.077786
Q3 1985 1.303317 35.631592 0.225607 10.263622 0.000553 0.050212 61.017211
Q4 1985 1.339411 36.775799 0.267799 10.526762 0.000629 0.053490 61.485865
Q1 1986 1.360229 39.270129 0.226208 10.791490 0.000514 0.055208 62.073685
Q2 1986 1.139583 39.965515 0.235453 11.287490 0.000497 0.051416 62.320214
Q3 1986 1.453483 40.282150 0.225422 11.436643 0.000575 0.053335 62.916865
Q4 1986 1.365320 40.336523 0.252227 12.245098 0.000634 0.058265 63.234251
Q1 1987 1.177421 40.270304 0.243621 11.870308 0.000557 0.061259 63.650310
Q2 1987 1.321208 40.147564 0.251630 11.979388 0.000587 0.064461 64.350320
Q3 1987 1.365558 39.774291 0.239663 11.981914 0.000580 0.067674 64.934423
Q4 1987 1.466332 39.941429 0.277968 11.757014 0.000729 0.066890 66.068174
Q1 1988 1.311326 39.309907 0.240980 12.178727 0.000563 0.069396 66.391596
Q2 1988 1.328772 39.287950 0.257463 12.134131 0.000581 0.068734 67.235458
Q3 1988 1.379507 39.631179 0.244611 11.995524 0.000632 0.068789 67.593675
Q4 1988 1.485926 39.335801 0.285781 11.837507 0.000719 0.068055 68.486417
Q1 1989 1.321394 38.574813 0.246283 11.599393 0.000571 0.070672 69.181103
Q2 1989 1.380881 39.325451 0.258404 11.495509 0.000551 0.073468 69.635105
Q3 1989 1.413221 38.260096 0.246474 11.369944 0.000565 0.071481 70.131467
Q4 1989 1.374302 38.156660 0.287682 11.432101 0.000650 0.076918 70.309474
Q1 1990 1.177993 38.327513 0.246048 11.344761 0.000592 0.072659 71.121244
Q2 1990 1.200848 38.837025 0.246841 11.397749 0.000561 0.072402 71.302653
Q3 1990 1.424871 42.445692 0.227341 11.352322 0.000505 0.070215 71.307676
Q4 1990 1.097834 44.697792 0.238902 11.319435 0.000468 0.063137 70.768821
Q1 1991 1.039719 41.803030 0.193994 11.378123 0.000385 0.058501 70.408246
Q2 1991 1.199444 40.595719 0.199092 11.407202 0.000366 0.059716 70.864849
Q3 1991 1.450470 38.595932 0.199091 11.680323 0.000360 0.062182 71.207027
Q4 1991 1.272688 37.792212 0.238739 11.957602 0.000404 0.064359 71.541441
Q1 1992 1.463795 35.626897 0.211857 12.202083 0.000367 0.066970 72.282288
Q2 1992 1.370504 35.439772 0.212063 12.309425 0.000353 0.073209 72.979464
Q3 1992 1.646444 34.190386 0.217048 12.659444 0.000343 0.070462 73.694849
Q4 1992 1.383287 33.999270 0.253575 13.020574 0.000395 0.070070 74.506889
Q1 1993 1.249731 34.429348 0.218026 12.966390 0.000368 0.072652 74.597467
Q2 1993 1.370667 36.690843 0.209294 13.346222 0.000346 0.071837 74.975281
Q3 1993 1.508767 39.131392 0.199672 13.718509 0.000316 0.070756 75.359941
Q4 1993 0.951794 35.877662 0.230426 13.916782 0.000343 0.070454 76.374245
Q1 1994 1.170647 34.847495 0.209725 14.173228 0.000335 0.070868 77.150640
 48

Q2 1994 1.177222 33.868144 0.218596 13.919863 0.000345 0.075044 78.157169

Q3 1994 1.288620 32.444659 0.226315 13.676716 0.000354 0.079125 78.594278
Q4 1994 1.327369 30.493014 0.283841 13.532869 0.000441 0.085678 79.516778
Q1 1995 1.230570 31.800251 0.242767 13.447695 0.000385 0.087805 79.737026
Q2 1995 1.164258 31.037380 0.239734 13.399355 0.000379 0.085730 79.879925
Q3 1995 1.310334 30.737906 0.238392 13.117659 0.000365 0.088222 80.530507
Q4 1995 1.077331 30.469597 0.277367 12.891010 0.000405 0.089479 81.119882
Q1 1996 1.063238 29.666588 0.241061 12.649481 0.000353 0.090890 81.691882
Q2 1996 0.989834 29.626013 0.247955 12.490691 0.000375 0.091911 83.031316
Q3 1996 1.040846 29.484499 0.252071 12.742761 0.000369 0.097595 83.726943
Q4 1996 1.461018 29.549252 0.283673 12.411007 0.000418 0.100003 84.705664
Q1 1997 1.059527 29.185499 0.252704 12.392245 0.000386 0.102037 85.360322
Q2 1997 1.134549 28.987679 0.259264 12.376359 0.000423 0.106648 86.658614
Q3 1997 1.269459 36.708546 0.230249 12.267677 0.000353 0.093618 87.736931
Q4 1997 1.176267 42.698953 0.223443 12.226809 0.000333 0.079225 88.383970
Q1 1998 1.205730 38.607801 0.166529 12.310436 0.000233 0.065910 89.362050
Q2 1998 1.356164 42.748863 0.175522 12.392684 0.000268 0.068978 89.953350
Q3 1998 1.735324 43.679466 0.161495 12.250434 0.000226 0.060916 90.988820
Q4 1998 1.661734 38.323510 0.192730 12.102875 0.000257 0.067081 92.370376
Q1 1999 1.443716 37.295357 0.177876 12.211452 0.000230 0.074290 93.154889
Q2 1999 1.494490 36.932259 0.189559 12.212832 0.000271 0.079192 93.925814
Q3 1999 1.739186 39.755300 0.186029 12.290791 0.000240 0.082109 95.021834
Q4 1999 1.614779 38.851743 0.205984 12.718005 0.000253 0.089503 96.711334
Q1 2000 1.420666 41.391714 0.190561 12.244474 0.000245 0.084792 96.956312
Q2 2000 1.695937 43.574456 0.191943 11.920906 0.000278 0.083774 98.479222
Q3 2000 1.968971 46.308798 0.180724 11.645295 0.000241 0.079816 98.365932
Q4 2000 2.093790 49.138388 0.185434 11.626874 0.000231 0.071772 98.877377
Q1 2001 1.361353 47.876479 0.161706 11.487068 0.000180 0.071583 98.755395
Q2 2001 1.143929 50.916012 0.162635 11.480062 0.000205 0.071080 99.058209
Q3 2001 1.479232 49.285847 0.160688 11.865198 0.000182 0.066213 98.710494
Q4 2001 1.746010 48.906013 0.182873 11.537273 0.000197 0.065362 99.100697
Q1 2002 1.255832 48.522497 0.161579 11.154003 0.000162 0.069984 99.773096
Q2 2002 1.087088 48.070472 0.172989 11.071788 0.000203 0.074672 100.315573
Q3 2002 1.203146 49.763749 0.165843 11.396861 0.000183 0.076105 100.906756
Q4 2002 1.244661 50.370341 0.191779 11.403519 0.000185 0.076031 100.957038
Q1 2003 0.955623 50.718596 0.163376 11.480352 0.000153 0.074107 101.259884
Q2 2003 0.970285 50.513477 0.172092 11.797035 0.000180 0.075655 102.127058
Q3 2003 1.031500 51.430510 0.169228 11.895374 0.000172 0.075335 103.986455
Q4 2003 0.970448 51.755451 0.193748 12.082537 0.000174 0.076914 104.669279
Q1 2004 0.704545 52.207219 0.168360 12.188335 0.000145 0.076659 105.435637
 49

Q2 2004 0.797390 51.900029 0.176275 12.129296 0.000161 0.076588 106.342853

Q3 2004 1.090717 50.690752 0.174901 12.339222 0.000149 0.075545 107.287350
Q4 2004 0.907174 50.071920 0.198896 12.433574 0.000149 0.076370 107.964146
Q1 2005 0.838788 48.227775 0.176933 12.349184 0.000133 0.079075 108.758556
Q2 2005 0.779617 49.164774 0.187427 12.249757 0.000162 0.080304 109.460951
Q3 2005 0.795478 48.894320 0.181691 12.065008 0.000133 0.080560 110.499877
Q4 2005 0.850612 45.824011 0.214433 12.013315 0.000140 0.080509 110.861384
Q1 2006 1.079087 43.595174 0.196655 12.038693 0.000142 0.086032 112.172280
Q2 2006 0.900253 45.851426 0.203135 11.774430 0.000162 0.089191 112.916427
Q3 2006 1.133955 42.793813 0.206541 11.625726 0.000141 0.094021 113.140974
Q4 2006 0.999827 41.253622 0.246803 11.669754 0.000160 0.105030 113.563857
Q1 2007 1.042096 40.838723 0.224250 11.637270 0.000156 0.117188 113.578970
Q2 2007 1.069729 39.746167 0.245344 11.325273 0.000192 0.125592 114.913924
Q3 2007 1.155690 38.213803 0.246323 11.357938 0.000163 0.125009 116.257906
Q4 2007 1.116126 34.998037 0.304567 11.274859 0.000187 0.133924 116.207151
 50

Appendix 4. Philippines-Japan dataset

QUARTER YD GOV TBRP- MWJAPAN RER (P/Y) YWJAPAN MD

JAPAN
Q1 1985 0.255861 0.000527 1.308184 4.306847 0.194643 13.940242 0.048374
Q2 1985 0.264675 0.000531 1.220723 4.408816 0.198389 14.406136 0.049148
Q3 1985 0.225607 0.000553 1.045786 4.585454 0.225885 15.273345 0.050212
Q4 1985 0.267799 0.000629 1.091902 5.298580 0.251028 17.900468 0.053490
Q1 1986 0.226208 0.000514 1.109438 5.909637 0.298966 19.731824 0.055208
Q2 1986 0.235453 0.000497 1.124131 6.713293 0.332742 21.882265 0.051416
Q3 1986 0.225422 0.000575 0.810383 7.455881 0.355728 24.169542 0.053335
Q4 1986 0.252227 0.000634 0.850892 7.591025 0.341953 23.705522 0.058265
Q1 1987 0.243621 0.000557 0.728326 7.979650 0.366367 24.833915 0.061259
Q2 1987 0.251630 0.000587 0.945170 8.715423 0.362073 26.874976 0.064461
Q3 1987 0.239663 0.000580 0.770926 8.671734 0.355503 26.635117 0.067674
Q4 1987 0.277968 0.000729 0.970734 9.359308 0.420677 29.479613 0.066890
Q1 1988 0.240980 0.000563 0.917009 10.256416 0.403062 31.857292 0.069396
Q2 1988 0.257463 0.000581 0.986741 10.470980 0.379329 32.714900 0.068734
Q3 1988 0.244611 0.000632 0.950873 9.933403 0.372269 31.312957 0.068789
Q4 1988 0.285781 0.000719 0.913952 10.881656 0.393906 33.858218 0.068055
Q1 1989 0.246283 0.000571 0.837300 10.907607 0.362092 33.918247 0.070672
Q2 1989 0.258404 0.000551 0.770911 9.626012 0.340729 31.099844 0.073468
Q3 1989 0.246474 0.000565 0.683552 9.942920 0.340666 30.684753 0.071481
Q4 1989 0.287682 0.000650 0.638231 9.555037 0.328787 31.296834 0.076918
Q1 1990 0.246048 0.000592 0.724967 9.689491 0.297341 30.313951 0.072659
Q2 1990 0.246841 0.000561 0.617817 9.263479 0.310844 29.605589 0.072402
Q3 1990 0.227341 0.000505 0.676612 9.898660 0.371476 32.090503 0.070215
Q4 1990 0.238902 0.000468 0.692579 10.442222 0.400966 35.740705 0.063137
Q1 1991 0.193994 0.000385 0.738353 10.291476 0.356257 35.438964 0.058501
Q2 1991 0.199092 0.000366 0.692705 10.100539 0.355316 34.288175 0.059716
Q3 1991 0.199091 0.000360 0.660450 10.153085 0.347917 34.670256 0.062182
Q4 1991 0.238739 0.000404 0.690712 10.793794 0.363205 36.967099 0.064359
Q1 1992 0.211857 0.000367 0.635666 10.840468 0.318397 37.318880 0.066970
Q2 1992 0.212063 0.000353 0.570845 10.696817 0.337968 36.853193 0.073209
Q3 1992 0.217048 0.000343 0.531686 11.350009 0.339234 38.559956 0.070462
Q4 1992 0.253575 0.000395 0.535631 11.592135 0.321137 39.023651 0.070070
Q1 1993 0.218026 0.000368 0.476248 11.978929 0.345754 40.197765 0.072652
Q2 1993 0.209294 0.000346 0.433177 13.022353 0.402418 43.725755 0.071837
Q3 1993 0.199672 0.000316 0.475319 13.774808 0.435887 45.335373 0.070756
Q4 1993 0.230426 0.000343 0.422898 13.862429 0.372138 44.247225 0.070454
Q1 1994 0.209725 0.000335 0.376894 13.972169 0.389963 43.463241 0.070868
 51

Q2 1994 0.218596 0.000345 0.332503 14.567640 0.393757 45.224264 0.075044

Q3 1994 0.226315 0.000354 0.388862 15.523678 0.375199 47.709958 0.079125
Q4 1994 0.283841 0.000441 0.386171 15.649035 0.348276 47.644135 0.085678
Q1 1995 0.242767 0.000385 0.485779 16.324498 0.400008 49.032915 0.087805
Q2 1995 0.239734 0.000379 0.411870 19.573588 0.409668 56.575047 0.085730
Q3 1995 0.238392 0.000365 0.451775 19.148172 0.346844 51.278105 0.088222
Q4 1995 0.277367 0.000405 0.402620 17.845385 0.326884 47.578044 0.089479
Q1 1996 0.241061 0.000353 0.515173 18.004208 0.304348 45.900158 0.090890
Q2 1996 0.247955 0.000375 0.465312 17.952221 0.294357 45.612488 0.091911
Q3 1996 0.252071 0.000369 0.497293 17.978635 0.286856 45.221123 0.097595
Q4 1996 0.283673 0.000418 0.670687 17.553720 0.273775 44.323049 0.100003
Q1 1997 0.252704 0.000386 0.504791 16.647163 0.250588 41.540583 0.102037
Q2 1997 0.259264 0.000423 0.546916 16.753413 0.274766 41.762894 0.106648
Q3 1997 0.230249 0.000353 0.533780 17.310283 0.327572 42.208680 0.093618
Q4 1997 0.223443 0.000333 0.522987 18.660492 0.354308 39.852855 0.079225
Q1 1998 0.166529 0.000233 0.652994 18.272643 0.313203 38.228240 0.065910
Q2 1998 0.175522 0.000268 0.698270 17.397974 0.324969 35.899502 0.068978
Q3 1998 0.161495 0.000226 0.638555 17.334229 0.342565 34.973007 0.060916
Q4 1998 0.192730 0.000257 0.672406 20.516015 0.353840 40.931597 0.067081
Q1 1999 0.177876 0.000230 0.664798 21.743305 0.326071 41.735368 0.074290
Q2 1999 0.189559 0.000271 0.647244 21.694800 0.318972 40.490139 0.079192
Q3 1999 0.186029 0.000240 0.746610 23.960719 0.385614 43.025162 0.082109
Q4 1999 0.205984 0.000253 0.804911 26.637090 0.391577 47.030592 0.089503
Q1 2000 0.190561 0.000245 0.843864 26.407544 0.396128 46.758812 0.084792
Q2 2000 0.191943 0.000278 0.852915 26.658030 0.415625 47.073052 0.083774
Q3 2000 0.180724 0.000241 0.820297 27.252921 0.427008 46.712135 0.079816
Q4 2000 0.185434 0.000231 0.922034 26.687453 0.422328 46.168518 0.071772
Q1 2001 0.161706 0.000180 0.925246 25.530676 0.374744 43.140119 0.071583
Q2 2001 0.162635 0.000205 0.692339 25.440888 0.395911 41.305640 0.071080
Q3 2001 0.160688 0.000182 0.697791 26.716816 0.396925 41.144930 0.066213
Q4 2001 0.182873 0.000197 0.744229 25.545590 0.356227 40.297132 0.065362
Q1 2002 0.161579 0.000162 0.826443 26.904597 0.346058 37.749970 0.069984
Q2 2002 0.172989 0.000203 0.706636 29.328668 0.379821 39.689027 0.074672
Q3 2002 0.165843 0.000183 0.667356 31.412781 0.384131 42.615245 0.076105
Q4 2002 0.191779 0.000185 0.748389 31.474618 0.392541 41.381611 0.076031
Q1 2003 0.163376 0.000153 0.749901 36.431005 0.388925 42.619437 0.074107
Q2 2003 0.172092 0.000180 0.692560 37.276061 0.388588 43.036842 0.075655
Q3 2003 0.169228 0.000172 0.737694 38.436677 0.423634 43.646486 0.075335
Q4 2003 0.193748 0.000174 0.832705 42.132695 0.441818 47.823824 0.076914
Q1 2004 0.168360 0.000145 0.889562 42.430301 0.452487 49.101434 0.076659
 52

Q2 2004 0.176275 0.000161 0.986165 42.045613 0.427922 47.828356 0.076588

Q3 2004 0.174901 0.000149 1.024145 42.843116 0.406783 48.042228 0.075545
Q4 2004 0.198896 0.000149 1.262915 44.790442 0.427664 49.708652 0.076370
Q1 2005 0.176933 0.000133 0.948340 45.824799 0.394261 50.626414 0.079075
Q2 2005 0.187427 0.000162 0.769754 45.083443 0.386176 49.725478 0.080304
Q3 2005 0.181691 0.000133 0.929871 44.708165 0.369597 48.497676 0.080560
Q4 2005 0.214433 0.000140 0.933095 42.819491 0.330556 46.156960 0.080509
Q1 2006 0.196655 0.000142 1.120288 43.185871 0.313995 46.374652 0.086032
Q2 2006 0.203135 0.000162 1.298698 43.821293 0.333111 47.724138 0.089191
Q3 2006 0.206541 0.000141 1.039630 43.162823 0.302487 47.274421 0.094021
Q4 2006 0.246803 0.000160 0.983566 42.566564 0.290492 46.954734 0.105030
Q1 2007 0.224250 0.000156 1.100191 42.383733 0.286284 46.825491 0.117188
Q2 2007 0.245344 0.000192 1.181686 41.841411 0.262224 46.221429 0.125592
Q3 2007 0.246323 0.000163 1.089478 42.599147 0.269836 47.608049 0.125009
Q4 2007 0.304567 0.000187 0.937960 44.281086 0.248630 49.852502 0.133924
 53

Appendix 5. Time series plots of the variables

YD
0.35
0.3
0.25
0.2
0.15
YD
0.1
0.05
0
Q1 1997

Q1 2003
Q1 1985
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990
Q1 1991
Q1 1992
Q1 1993
Q1 1994
Q1 1995
Q1 1996

Q1 1998
Q1 1999
Q1 2000
Q1 2001
Q1 2002

Q1 2004
Q1 2005
Q1 2006
Q1 2007
Philippine real domestic product in billion dollars
Source: International Financial Statistics

RP GOV
0.0008
0.0007
0.0006
0.0005
0.0004
0.0003
0.0002 RP GOV
0.0001
0
Q1 1991

Q1 1995
Q1 1985
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990

Q1 1992
Q1 1993
Q1 1994

Q1 1996
Q1 1997
Q1 1998
Q1 1999
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007

Philippine real government expenditure in billion dollars

Source: International Financial Statistics
 10
12
14
16

0
2
4
6
8
0.1

0
0.02
0.04
0.06
0.08
0.12
0.14
0.16
Q1 1985
Q1 1985
Q1 1986
Q1 1986
Q1 1987
Q1 1988 Q1 1987
Q1 1989 Q1 1988
Q1 1990 Q1 1989
Q1 1991 Q1 1990
Q1 1992 Q1 1991
Q1 1993 Q1 1992

US real money in billion dollars

Q1 1994 Q1 1993
Q1 1995 Q1 1994
Q1 1996

Philippine real money in billion dollars

Q1 1995

Source: International Financial Statistics

Source: International Financial Statistics
Q1 1997 Q1 1996
Q1 1998 Q1 1997
Q1 1999
MD

Q1 1998
Q1 2000 Q1 1999

USmoney
Q1 2001 Q1 2000
Q1 2002
Q1 2001
Q1 2003
Q1 2002
Q1 2004
Q1 2003
Q1 2005
Q1 2004
Q1 2006
Q1 2005
Q1 2007
Q1 2006
Q1 2007
54

MD

USmoney
 10
15
20
25
30
35
40
45
50

0
5
20
40
60
80

0
100
120
140
Q1 1985
Q1 1985
Q1 1986
Q1 1986
Q1 1987
Q1 1987
Q1 1988
Q1 1989 Q1 1988
Q1 1990 Q1 1989
Q1 1991 Q1 1990
Q1 1992 Q1 1991
Q1 1993 Q1 1992
Q1 1994 Q1 1993

Japan real money in billion dollars

Q1 1995 Q1 1994
Q1 1996 Q1 1995
Q1 1997

Source: International Financial Statistics

Source: International Financial Statistics
Q1 1996
Q1 1998 Q1 1997
Q1 1999
Q1 1998
Q1 2000

US real gross domestic product in billion dollars

Q1 1999
USgdp

Q1 2001
Q1 2000
Q1 2002

JAPANmoney
Q1 2001
Q1 2003
Q1 2004 Q1 2002
Q1 2005 Q1 2003
Q1 2006 Q1 2004
Q1 2007 Q1 2005
Q1 2006
Q1 2007
55

JAPANmoney
USgdp
 56

JAPANgdp
60

50

40

30

20 JAPANgdp

10

0
Q1 1985

Q1 1999
Q1 1986
Q1 1987
Q1 1988
Q1 1989
Q1 1990
Q1 1991
Q1 1992
Q1 1993
Q1 1994
Q1 1995
Q1 1996
Q1 1997
Q1 1998

Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Japan real gross domestic product in billion dollars
Source: International Financial Statistics

Summary Statistics of the Data

Philippines Philippines-
RER RER
Variable -U.S. Trade Japan trade
peso/dollar peso/yen
Ratio ratio
Mean 0.7633 1.2553 40.374 0.3505
Median 0.7380 1.2472 39.483 0.3554
Minimum 0.3325 0.7045 28.988 0.1946
Maximum 1.3082 2.0938 52.207 0.4525
Standard deviation 0.2322 0.2547 6.3992 0.0539
C.V. 0.3041 0.2029 0.1585 0.1541
Skewness 0.2952 0.5067 0.1768 -0.6265
Ex. Kurtosis 0.5252 0.7731 -0.7989 0.2191
 57

Appendix 6. VAR Estimation of the Philippines-US model

GOV RER (P/$) RPMONEY TBRP-US YD

∆GOV(-1) -0.285533 12100.34 6.793901 -681.5693 30.70998

[-1.86393] [ 1.31754] [ 0.40040] [-0.82335] [ 0.56750]
∆GOV(-2) -0.589660 13221.24 -6.899895 803.7387 13.17396
[-5.03812] [ 1.88422] [-0.53225] [ 1.27081] [ 0.31864]
∆GOV(-3) -0.333842 7847.157 0.960288 -1073.041 10.01369
[-2.28796] [ 0.89704] [ 0.05942] [-1.36089] [ 0.19427]
∆RER (P/$) (-1) -5.83E-06 0.046738 -0.001413 -0.006360 -0.004483
[-2.60065] [ 0.34750] [-5.68842] [-0.52461] [-5.65660]
∆RER (P/$) (-2) -1.60E-06 -0.036145 -0.000253 -0.014091 -0.002227
[-0.58614] [-0.22027] [-0.83612] [-0.95268] [-2.30315]
∆RER (P/$) (-3) 3.76E-07 0.276573 -4.54E-05 -0.001807 -0.001493
[ 0.15160] [ 1.85986] [-0.16536] [-0.13480] [-1.70347]
∆MD(-1) 0.001771 47.76570 0.017036 -1.485346 0.828825
[ 1.45878] [ 0.65617] [ 0.12668] [-0.22638] [ 1.93234]
∆MD (-2) 0.003521 12.30236 0.206716 3.091909 1.812174
[ 2.88795] [ 0.16830] [ 1.53072] [ 0.46929] [ 4.20754]
∆MD (-3) 0.001742 45.49040 -0.023640 -0.583481 1.250893
[ 1.72561] [ 0.75177] [-0.21146] [-0.10698] [ 3.50835]
TBRP-US (-1) -7.62E-06 0.549370 0.001631 0.653929 0.002292
[-0.35238] [ 0.42348] [ 0.68060] [ 5.59252] [ 0.29991]
TBRP-US (-2) 3.54E-05 -0.888873 0.002395 -0.107904 0.002759
[ 1.34797] [-0.56489] [ 0.82385] [-0.76080] [ 0.29753]
TBRP-US (-3) -1.40E-05 1.919672 -0.004377 0.325493 -0.005128
[-0.64167] [ 1.46259] [-1.80499] [ 2.75134] [-0.66305]
∆YD(-1) -0.000820 -43.94112 -0.006644 -1.095470 -0.927077
[-2.23908] [-2.00247] [-0.16389] [-0.55386] [-7.17020]
∆YD(-2) -0.000141 -31.32084 0.026098 -4.714096 -0.854452
[-0.39576] [-1.46846] [ 0.66229] [-2.45208] [-6.79886]
∆YD(-3) -0.000643 -2.781697 -0.009358 1.901304 -0.915292
[-1.76643] [-0.12743] [-0.23205] [ 0.96635] [-7.11630]
C -4.58E-05 -1.717688 0.001142 0.128984 -0.003368
[-2.00493] [-1.25453] [ 0.45137] [ 1.04515] [-0.41746]
∆YWUS 2.08E-05 -0.400645 0.000155 0.040724 0.001566
[ 2.52638] [-0.81067] [ 0.16926] [ 0.91420] [ 0.53790]
∆MWUS -2.22E-05 -1.071888 0.001979 -0.043283 -0.009670
[-1.40066] [-1.12983] [ 1.12891] [-0.50616] [-1.72981]

R-squared 0.647910 0.251604 0.524699 0.639974 0.826015

Adj. R-squared 0.562402 0.069850 0.409269 0.552539 0.783761
Sum sq. resids 7.24E-08 260.2373 0.000888 2.114239 0.009035
 58

S.E. equation 3.22E-05 1.928128 0.003562 0.173791 0.011361

F-statistic 7.577214 1.384314 4.545601 7.319442 19.54903
Log likelihood 795.5413 -172.5739 381.2908 39.19365 279.2288
Akaike AIC -17.67139 4.331225 -8.256610 -0.481674 -5.937017
Schwarz SC -17.16467 4.837953 -7.749882 0.025054 -5.430289
Mean dependent -5.03E-06 -0.020202 0.000914 1.256081 0.000418
S.D. dependent 4.86E-05 1.999214 0.004635 0.259807 0.024431

Determinant resid covariance (dof adj.) 4.58E-20

Determinant resid covariance 1.46E-20
Log likelihood 1385.356
Akaike information criterion -29.43991
Schwarz criterion -26.90627
 59

Appendix 7. VEC Estimation of the Philippines-Japan model

VECM system, lag order 3

Maximum likelihood estimates, observations 1985:4-2007:4 (T = 89)
Co-integration rank = 1
Case 4: Restricted trend, unrestricted constant
beta (co-integrating vectors, standard errors in parentheses)

TB 1.0000
(0.00000)
YD 341.97
(36.45)
GOV -35000.
(9380.1)
RER 86.71
(11.41)
MD -387.32
(62.20)
trend 0.61
(0.083)

alpha (adjustment vectors)

TB -0.0058
YD -0.0046
GOV -6.52e-006
RER -0.0054
MD -0.00017

Log-likelihood = 1757.80
Determinant of covariance matrix = 4.81e-024
AIC = -37.48
BIC = -34.96
HQC = -36.46
 60

Equation 1: TBRP-JAPAN

Variable Coefficient Std. Error t-statistic p-value

Const 0.27 0.33 0.80 0.43

ΔTBt-1 -0.28 0.12 -2.39 0.019 **

ΔTBt-2 -0.17 0.12 -1.423 0.16

ΔYDt-1 2.194 1.55 1.41 0.16

ΔYDt-2 0.73 1.06 0.68 0.50

ΔGOVt-1 -413.37 403.43 -1.02 0.31

ΔGOVt-1 232.50 389.36 0.60 0.55

ΔRERt-1 0.22 0.45 0.49 0.63

ΔRERt-1 -0.073 0.45 -0.16 0.87

ΔMDt-1 -2.21 3.61 -0.61 0.54

ΔMDt-2 -4.32 3.28 -1.32 0.19

MWJAPAN 0.0046 0.0040 1.16 0.25

YWJAPAN 0.0043 0.0034 1.28 0.20

EC -0.0058 0.0055 -1.05 0.30

Mean of dependent variable = -0.00121152

Standard deviation of dep. var. = 0.105637
Sum of squared residuals = 0.847785
Standard error of residuals = 0.107035
Unadjusted R2 = 0.13668
Durbin-Watson statistic = 1.97012
First-order autocorrelation coeff. = -0.0150852
 61

Equation 2: YD

Variable Coefficient Std. Error t-statistic p-value

ΔTBt-1 0.26 0.053 4.94 <0.00001 ***

ΔTBt-2 -0.031 0.019 -1.68 0.09649 *

ΔYDt-1 -0.024 0.019 -1.24 0.21871

ΔYDt-2 0.37 0.25 1.51 0.13538

ΔGOVt-1 0.36 0.17 2.12 0.03771 **

ΔGOVt-1 -69.36 64.34 -1.078 0.28451

ΔRERt-1 -47.49 62.10 -0.76 0.44686

ΔRERt-1 -0.10 0.072 -1.41 0.16159

ΔMDt-1 0.057 0.072 0.79 0.43233

ΔMDt-2 -0.84 0.57 -1.46 0.14836

MWJAPAN 0.41 0.52 0.79 0.43103

YWJAPAN 0.0033 0.00063 5.28 <0.00001 ***

EC 0.0023 0.00054 4.27 0.00006 ***

ΔTBt-1 -0.0046 0.00088 -5.22 <0.00001 ***

Mean of dependent variable = 0.00088719

Standard deviation of dep. var. = 0.0246925
Sum of squared residuals = 0.0215633
Standard error of residuals = 0.0170703
Unadjusted R2 = 0.59811
Durbin-Watson statistic = 1.71413
First-order autocorrelation coeff. = 0.124764
 62

Equation 3: GOV

Variable Coefficient Std. Error t-statistic p-value

ΔTBt-1 0.00038 0.00011 3.36 0.00122 ***

ΔTBt-2 -6.90e-05 3.98e-05 -1.73 0.08730 *

ΔYDt-1 3.31e-05 4.07e-05 0.81 0.41928

ΔYDt-2 0.00065 0.00053 1.23 0.22269

ΔGOVt-1 0.0013 0.00036 3.67 0.00045 ***

ΔGOVt-1 -0.176 0.14 -1.28 0.20346

ΔRERt-1 -0.58 0.13 -4.38 0.00004 ***

ΔRERt-1 -0.00030 0.00015 -1.96 0.05436 *

ΔMDt-1 0.00012 0.00015 0.80 0.42761

ΔMDt-2 -0.00065 0.0012 -0.53 0.60041

MWJAPAN 0.0011 0.0011 0.95 0.34509

YWJAPAN 4.54e-06 1.35e-06 3.37 0.00120 ***

EC 2.98e-06 1.15e-06 2.59 0.01162 **

ΔTBt-1 -6.52e-06 1.88e-06 -3.48 0.00085 ***

Mean of dependent variable = -4.11303e-006

Standard deviation of dep. var. = 4.90826e-005
Sum of squared residuals = 9.84311e-008
Standard error of residuals = 3.64712e-005
Unadjusted R2 = 0.53570
Durbin-Watson statistic = 2.0804
First-order autocorrelation coeff. = -0.0467444
 63

Equation 4: RERP/Y

Variable Coefficient Std. Error t-statistic p-value

ΔTBt-1 0.35 0.08 4.69 0.00 ***

ΔTBt-2 0.01 0.03 0.40 0.69

ΔYDt-1 0.03 0.03 1.22 0.23

ΔYDt-2 0.85 0.35 2.42 0.02 **

ΔGOVt-1 0.26 0.24 1.08 0.28

ΔGOVt-1 -26.19 91.42 -0.29 0.78

ΔRERt-1 21.67 88.23 0.25 0.81

ΔRERt-1 0.05 0.10 0.51 0.61

ΔMDt-1 -0.22 0.10 -2.14 0.04 **

ΔMDt-2 -0.90 0.82 -1.10 0.27

MWJAPAN -0.78 0.74 -1.05 0.30

YWJAPAN 0.0036 0.00090 3.96 0.00 ***

EC 0.0019 0.00076 2.46 0.02 **

ΔTBt-1 -0.01 0.0012 -4.35 0.00 ***

Mean of dependent variable = 0.000255558

Standard deviation of dep. var. = 0.0280398
Sum of squared residuals = 0.0435301
Standard error of residuals = 0.0242538
Unadjusted R2 = 0.37085
Durbin-Watson statistic = 1.85929
First-order autocorrelation coeff. = 0.0561739
 64

Equation 5: MD

Variable Coefficient Std. Error t-statistic p-value

ΔTBt-1 0.01 0.01 0.95 0.35

ΔTBt-2 0.0031 0.0045 -0.69 0.49

ΔYDt-1 0.0011 0.0046 -0.24 0.81

ΔYDt-2 0.07 0.06 1.22 0.22

ΔGOVt-1 0.09 0.04 2.18 0.03 **

ΔGOVt-1 -0.72 15.67 -0.05 0.96

ΔRERt-1 -13.64 15.12 -0.90 0.37

ΔRERt-1 -0.04 0.02 -1.99 0.05 **

ΔMDt-1 0.00 0.02 -0.13 0.90

ΔMDt-2 0.17 0.14 1.20 0.23

MWJAPAN 0.06 0.13 0.50 0.62

YWJAPAN 0.00017 0.00015 1.12 0.27

EC 0.00001 0.00013 0.10 0.92

ΔTBt-1 -0.00017 0.00021 -0.79 0.43

Mean of dependent variable = 0.000940583

Standard deviation of dep. var. = 0.00461517
Sum of squared residuals = 0.00127906
Standard error of residuals = 0.00415747
Unadjusted R2 = 0.31761
Durbin-Watson statistic = 1.96918
First-order autocorrelation coeff. = 0.00222439
65