Philippine Institute for Development Studies
Can P* Be a Basis for Core Inflation in the Philippines? Josef T. Yap DISCUSSION PAPER SERIES NO. 96-10
The PIDS Discussion Paper Series constitutes studies that are preliminary and subject to further revisions. They are being circulated in a limited number of copies only for purposes of soliciting comments and suggestions for further refinements. The studies under the Series are unedited and unreviewed. The views and opinions expressed are those of the author(s) and do not necessarily reflect those of the Institute. Not for quotation without permission from the author(s) and the Institute.
September 1996 For comments, suggestions or further inquiries please contact: The Research Information Staff, Philippine Institute for Development Studies 3rd Floor, NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, Makati City, Philippines Tel Nos: 8924059 and 8935705; Fax No: 8939589; E-mail: publications@pidsnet.pids.gov.ph Or visit our website at http://www.pids.gov.ph
CAN
P*
BE
A
BASIS
IN
FOR
THE
CORE
INFLATION
PHILIPPINES?
Josef
T.
Yap I
Introduction Inflation discussions Governor the
with of
of
ingredient its
concept
core
inflation
trend
usually
excluded
in 2)
the
of
to
relate
it
can
be
for
inflation the
is
one
the
BSP
the
rate is
is
intent
reason as
that
that
a
basis
BSP
to
a to
the for
the
in
inflation
applied
in
by
level.
policy
volatile
core
defined
of such
some
items
core as
seasonal.
to
concept
the
Philippine
be
that
and
are: changes
interest of
In
this
P*
and
the are
inflation
taxes
countries,
and/or
the
the
The
computation
and,
are
is
rates; paper
we
determine
economy.
Concepts The
Reserve
P-star as
a
(P*)
simple,
concept yet
was
first
goods
and
price level P* indicate materialized level.
financial
P and the and
markets.
P* is amount can
developed
comprehensive,
pressure (Hallman, et al. 1989, 1991). level which is consistent with current in
percent
considered
price
government oil
which
whether
Basic
general
from to
attempt
being
and
admitting
i0
and
This
inflation
the
subject price
above
stability
economic
Planning (BSP)
manageable
line.
in
policy.
in
components
remain
is
again
Pilipinas
steady, this
"underlying"
long-run
prices
A
issue
Socio-economic
ng
likely
along
or
of
macroeconomic
monetary
Core
I)
will
mandate
of
conducting
central
Sentral
1996.
for
the
Secretary
Bangko
rate
quarter
pursue
become
t_e
the
inflation
first key
has
zero of
help
As
indicator
of
the
Federal
inflationary
P* is defined as the price money supply and equilibrium the
gap
in equilibrium, price adjustment predict
by
future
between
deviations which
movements
the
actual
from P and has not yet in
the
price
1Research Fellow, Philippine Institute for Development Studies. This paper was prepared for a workshop on the definition and measurement of inflation organized by the Bangko Sentral ng Pilipinas and held on 16 February 1996. The usual disclaimer applies.
2
Calculation starting
of
point.
P*
The
takes
simple
PQ
where
Q
money the
is
and
real V
long-run
defined the
the
long-run of
quantity
P is
price
the
GDP of
price
level
equation
of
money
as
the
is:
deflator, P*
level
value
real
price money.
and,
consistent
equilibrium
potential
theory
(i)
velocity
equilibrium
as
value
the
quantity
MV
GDP,
is
the
GDP
of
with
M
is
is
also
based
on
the
current
velocity
the
stock
Equation
(V*),
(I),
value
and
as
the
of
M,
current
(Q*) :
MV"
p-
of
considered
(2)
Q-
Following V*
are
are
independent
level
moves As
from
quantity
actual
of
the
money
proportionally
actual -
identify and then
theory,
it
independently,
mentioned
the
gaps P* accelerate
run
the
determined
any
level
P, indicates or slow down.
P,
assumed
Thus,
the
stock
of
any
price
level
whether the An application
inflation
is
to
P*
and
imposed given
by
by the
thereby P*.
are
Such
following
both
Q*
and
that
equilibrium'
both price-
money.
of
the
positive
price
or
level
negative
P*
price
future price level of this framework
the equilibrium price level through to estimate reduced-form short-run
constraints
the
divergence i.e.
that
moreimportantly
stock.
with
earlier, price
is
and,
will is to
the construction of P* dynamics that drive the
consistent
with.
a short-run
the
dynamic
error-correction
long-
model
of
model:
N ALn
(Pt)
Hoeller on
the
and
adjustment
does
not
run,
e.g.
then
_ _i ALn i.1
capture indirect
provides
Poret
(P) _-i"_ (Pt-l" -Pt-I )
(1991)
towards important tax
a measure
out
long-run factors
changes, of
point
where
(3)
that
Equation
equilibrium influencing
food the
or price
energy level
(3)
levels; prices will
hence
in
price
focuses
the
shocks. go
after
it
short P* such
3
transitory shocks have worked characterization that links the
The
idea
increase
in
increase run
behind the
of
of
approach
P*
Calculation
A
key
the
of
P*
question
outset,
it V
will
values
out
in
price
gap,
assumption
of
One
the
of
applied
by
derive
an
Another equilibrium stochastic it
Once used price
to
to
gap
P*-P
P
to
of
unit
root
At
unit
roots
trends
will
to the
actual
to long
equilibrium
is
how
and
revert in the
time
and
is Q
or
in some run. mean
velocity. yield
inconsistent
use
Hall
structural
a
non-
with I
the
and
models
equilibrium
(1992)
to
of
potential
velocity.
computing
computational
of P*.
contains
Q*
and
V*
next a
This
for
of is
potential filters the Kalman
difficulty. which
The
the
V*
and
versions framework
of to
output.
for
filter
of
calculate
by Reyes and Yap (1993). Earlier an aggregate production function
estimates estimate
of
do not averages
which
output
and
alternative
some
presence
output
P*-P,
potential
Hodrick-Prescott
Granger for
(V*) .
output
(deterministic)
velocity is the use trends. The most popular
entails
the
a
model.
Funke
estimate
The
presence
is
subsequently adopted the PIDS model used
valid
and
approach
velocity
actual
that they historical
of
i.e.
alternative
determination was
the
P*
long-
a
form
tendency
P*
trend
whether
potential
trends
the
and
root.
use
calculating
time
an
the
must
Engle
a
any
by
be
P*
of be
P in
to
and
sense
should
(Q*)
unit
the
stationary
of
(3) P
that
accompanied
increase
implementing
velocity implies time trends or
for
Using
a
not
is
the
run.
determined
contain
rule
the
This is inflation.
therefore
is
however, in
in
be
(3)
an
out. core
to
equation
there
output
must
output and deterministic
cause
data,
long
and
which
For
words,
in
potential
This
will
.the
other
measure velocity
money
relationship In
(2)
_>0) .
representation cointegrating
of
output,
that
(1987).
equations
stock
real
(note
themselves P* concept
unit
is are
more
root.
is
and
to compute for filter although
Hoeller
and
Poret
use
straightforward.
obtained
step
output
Equation
to
determine
If
it
is
(2)
is
whether shown
that
then the .,the
4 assumptions around
of
the
Equation
Empirical
test
for
Dickey-Fuller
The
null
0.
For
= Y
+
against
p
HA:
= p
Three
we y
=
an
inflation
model
built
on
calculated
based
on
three
we
apply
following
augmented
regression:
nonstationary,
hypotheses,
to
an
+ et is
HA:
p
<
H0:
0
account
tested
output
;and
for
@ = H0:
the
i.e.
been
money
0 against p =
0,
be
that
bias
the
in
liquidity.
that
ÂŁhe
or
mean
The
null it
while
of
to
ADF
is
values
the test
and
In a
over
P*2)
A unit
apply
are root
nonstationary
unit
tests
not
possible calculating
of
the
structural
the
null
hypothesis.
time the
plotted test and
and
V*
was
PGDP
that be
not
Given in
1983), breaks. data the
successful.
Hodrick-Prescott empirical taken
The
against
cannot
were
some
period.
reveals hence
the
present
trend sample
filter
for
to
in
hypothesis.
Kalman
program order
to
breaks
(e.g. the BOP crisis do exhibit structural
root
is
I
presence toward
V2
for
velocity.
the past variables
the
software
using
velocity
(P*1
is
reject
available.
computed
a
hypothesis-of
fail
a
of
v2
tests
not
0
and
(1994) applying a segmented trend model to Philippine that even if structural breaks are taken into account
addition,
=
velocity
Capuno shows
Attempts
=
HA: 8
V1 is
(i)
total
Hence
trends
Vl
Equation
rejected.
equilibrium
argued
will
or
GDP,
1981-1994.
using
show
time
the various crises several macroeconomic
to
p
possibility
stationarity:
period
money
broad
and
for
the
variables cannot
series
three
over
deterministic
has
the
series
against
narrow
on
nonstationarity
It
test is
y_
_SjAYt-j
+
the
are
data
based
potential
running
that
This
variables
these
series
series.
quarterly
computed
a
PYt-i
0
0
stationary
a time
satisfied,
in
by
+
is
0, <
roots
5t
hypothesis H0:
apply
are
estimated.
.(ADF)
completeness
< 0;
using
be
unit
test
_Yt
trend
model
Results
To
p
P*
3 can
to
filter
results, be
the
corresponding in
the used
Figures
resulting in
price
mean
values
i and
estimating
In Q*
is was
value of
P*
2. gap
(P*-P)
Equation
3.
5
A preliminary regression shows, however, on total liquidity (P*2 - P) yields better means
that
broad
money
seems
to
be
a
that the price gap empirical results
better
anchor
for
based which
monetary
policy.
Concluding
Remarks
Further
work
of
P*
a stationary
and
Q*
should
values
and
Previous better
this
exchange They the
price
larger
the
regime
P*
the
by
incorporating
of
imported
empirical the
include
a
of
foreign
Philippine
of
the
a
show
the
appropriate
realistic
gap
the
Kool of
value
the
fit
price
and of
gap for
of
gap.
estimating
seems
prices
price
especially
when
model
importance
foreign
that
foreign
price
that
determinants
inflation
results
addition
more
a more
countries.
neglect for
estimating
show
smaller
proceed
with
assure
of
gap.
influence
Their
on
would
using
than
to
rate
focus
This
studies
with
attribute
V*.
Tatom
P* would
(1994)
prevailing
and
inflation.
to
It
work
the
account
small
the
to
model
Equation
for
economies.
be
improves useful
(3)
for
to the
case.
References
Capuno, J. Series:
Engle,
R.
J. The
F.
(1994) "Exogenous Shocks Case of the Philippines."
and
C.
W.
Error Correction: Econometrica, 55,
Funke,
M.
and
from
S.
Other
Business
Hallman, Unit
Reserve
Study System,
No.
(1987):
No.
ii-
Washington
the
Study
Economic
and
Bundesbank
Based
on
Time
and
Testing,"
Different P*,"
London
Forecasting,
92.
Porter GNP as 157,
A
for
"Co-integration
Estimation,
"Is
Banks:
Centre
J. J., R. D. of Potential
Staff
(1992):
Central Paper
Granger
Representation, 251-276.
Hall
School,
Discussion
J.
and Nonstationary Manuscript.
and an
Board DC,
D. H. Anchor of
Small (1989): for the Price
Governors
April.
of
the
"M2 per Level," Federal
6 Hallman,
J.
Price
R.
Level
Long Hoeller,
J.,
Tied
Run?" P.
C. Five
and
P.
Reyes,
C.
17
J. M. Small
Review
Porter
to
American
Inflationary Studies No. Kool,
D.
Poret
and
the
M2
and J. A. Economies."
Small
"Is OECD
(1991):
"Is
Aggregate
Review
(1991): in
H.
Monetary
Economic
Pressure (Autumn).
D.
81,
P-Star
in
the the
841-858. a
Good
Countries?"
Indicator OECD
Tatom (1994): "The P-Star Federal Reserve Bank of
of
Economic
Model in St. Louis
(May/June). M.
Philippines Philippine
and
J.
T.
1981-1992: Development
Yap
(1993). A
"Money
Cointegration
XX,
36
(First
and
Prices
Analysis." Semester).
in
the
Journal
of
Figure
250
1: P*I and PGDP
200 •
#
150
•
.
.'"
100. ,,.;""
5O
81 82
83
84
85
86
87
88
89 I
P*I
...... PGDP II
90
91
92
•Figure 2:P*2
and PGDP
250
200
150-
,'" J'*
"_
100J
s _
,
i" _.1 II
50-
0
I
I
81
_
I
i
I
82
I
i
i
|
83
|_|
i
i.
84
I
I
I
85 --
I
J
I
I
86
_l I
i
I
87
I-" I
I'I
88
IFV_I
89
P*2 ...... PGDP I
|
I
i 1--'l"l'i
90
I
91
I
I
!
F
92