Macroeconomic policy and its impact on the Philippine economy

Abstract

The thesis aims to formulate a theoretical framework which enables us to analyze a country’s macroeconomic policy and its impact on the domestic economy, and then relate this analytical framework to the case of the Philippines. This objective of the thesis (atid hence its contribution) was based on the argument that while externa! shocks during the 1970s were indeed a necessary condition for the occurrence of the Philippine crisis during the 1980s, the domestic macroeconomic policy also contributed significantly to the economic debacle. The thesis answers three central questions: the first question focuses on the conduct/determination of the Philippine macroeconomic policy -fiscal, monetary, and exchange rate policy: the second question deals with the impact of domestic fiscal and money expansion under fixed and flexible exchange rates on the real exchange rate, the current account, employment and output; and the third question analyzes the impact of macroeconomic policy on the country’s debt, investment, savings and wealth. In response to the first central question, we provide an historical and analytical review of the Philippine fiscal, monetary and exchange rate policy. Philippine macroeconomic policy during the 1966-1984 period was generally too expansionary, which was a departure from the conservative policy during the 1950s and the early 1960s. The Philippine government has relied heavily on foreign borrowings, particularly during the 1970s, in order to finance the government budget deficits and the current account deficits. The Philippines had fixed exchange rate during the 1966-1969 period, and then allowed the peso-US dollar rate to float during the post-1970 period. The Central Bank has, however, intervened in the foreign exchange market. In response to the second central question, we develop a general theoretical framework in the context of the Salter-Swan tradeable and non-tradeable sectoral model. The basic medium-run model has three central assumptions; namely, (a) a small country assumption, (b) flexibility of the nominal wages to guarantee full employment, and (c) flexibility of non-tradeables prices to assure equilibrium in the non-tradeables market. YVe also analyze a Keynesian short-run model incorporating nominal wage rigidity. Then, we analyze the impact of pure money expansion and pure fiscal expansion under fixed and flexible exchange rates on the real exchange rate (the ratio of the domestic prices of tradeables to the domestic prices of non-tradeables), the current account, sectoral employment and output. We are able to come up with alternative estimates of the domestic prices of tradeables, domestic prices of non-tradeables, and the real exchange rates based on three alternative classifications of the tradeable sector and the nontradeable sector. We are also able to come up with alternative estimates of sectoral employment and sectoral output. Factual evidence, in the form of casual observations and some econometric work enabled us to confirm and conclude the* relevance of the? Salter-Swan theoretical framework in analyzing the effects of fiscal and monetary policy in the Philippines under fixed and flexible exchange rates. There also existed a significant relationship between the current account balance and the real exchange rate in the Philippines: the real exchange rate depreciated and the current account balance showed an improvement during the 1967-1973 period; and subsequently until 1984, the real exchange rate appreciated and the current account balance deteriorated. Such a significant relationship was attributed to the linkage between changes in the real exchange rates and the exogenous changes in fiscal and monetary policy, and to the linkage between changes in the real exchange rate and changes in the terms of trade. Employment and output trends showed consistency with the expected theoretical results: non-tradeable output increased while tradeable output decreased during the post-1973 period since the price of non-tradeables increased relative to tradeables; and non-tradeable employment increased while tradeable employment decreased during the same period presumably owing to the lower product wage of the non-tradeable sector relative to the product wage of the tradeable sector. In answer to the third central question, we develop a framework of analysis to explain each of the observed phenomena; namely, rising gross external debt, widening investment-savings gap. and increasing real wealth of the Philippines. We are able to come up with estimations or measures of the economic variables under investigation. We concluded that the financing of the current account deficits accounted for about two-thirds of the rise in the cumulative external debt of the Philippines during the 1971-1984 period, and the financing of private capital outflows accounted for about onethird. The public sector deficit accounted for a larger share in the widening of the national investment-savings gap, and the private sector deficit accounted for a smaller share. The growth of capital stock exceeded the growth of net external debt and hence real savings were positive. Real wealth appears to have been increasing, and that the Philippine debt problem is a liquidity problem which will be self-financing if the investments undertaken turn out to have been profitable. Show more