Countercyclical

The debate should be a little more vigorous – if there is any appetite for it.

Last month, the Monetary Board reversed a long trend by raising interest rates. The move was anticipated. The oil price shock will certainly drive up inflation. The Board’s mandate is to manage the inflation rate. Institutional reflex takes over.

The decision to increase rates by 25 basis points will likely be part of a series of rate escalations over the coming months. The impact on the inflation rate will probably be negligible. Prices are being pushed upward by cost spikes rather than by rising demand.

As the interest rate regime moves upward, certain sectors will feel the impact ahead of the rest. The property sector is almost immediately hit. One major property developer has pulled back in the face of tepid consumer demand.

Another sector that will be immediately hit is automotive sales. Higher interest rates makes it unattractive to invest in a new car at this time.

Other sectors driven by discretionary consumer spending will eventually follow. In a consumption-driven economy with a large service sector, which is what we have, this is significant. Luxury spending will take a nosedive. This will not only adversely affect the retail industry. The adverse impact on the earnings of golf caddies, for instance, is now palpable.

Raising interest rates often have the side effect of stabilizing the currency. The first round of interest rate increases have not had this effect. The peso continues to sink. Bank economists are looking at continued depreciation for the rest of the year. The most severe estimates see the peso declining to as low as $1:P65.

Raising interest rates might not be the sharpest instrument for dealing with a rising inflation rate driven by rising costs – not buy rising demand.

This instrument adds to the demand destruction already inflicted by rising costs. Demand destruction builds a trend towards recession. As it takes its toll, particularly in the form of job losses, demand destruction will not be easy to repair.

Every crisis that hit the global economy over the past few decades produced K-shaped effects. This means the rich get richer and the poor become poorer. Wealth distribution becomes worse. Billionaires thrive while wage-earners suffer.

The role of the state, during periods such as this one, should be to avert the sharpening of inequality. This is best done through public investments rather than through short-term subsidies.

When the 2008 financial crisis hit, the Macapagal-Arroyo administration set forth a package of countercyclical policies. At the core of this effort was increased investments in building infrastructure. The program prevented unemployment from rising. It created durables that will benefit the economy over the long term. It prevented the cycle of demand destruction from taking hold.

Raising interest rates has the opposite effect. It discourages investments by making borrowing costlier. It kills jobs rather than creates them. It inhibits economic activity rather than encouraging its flourishing.

We are standing on the edge of a recession. Consumers are reallocating their spending to cover the basics such as food, energy and transport while avoiding the discretionary. Businesses are feeling the effects now.

Higher interest rates will take a toll on bank lending. It will increase the risks for those in the credit card business. The derogatory advisories regarding our capital markets are not helpful. Out stock market is back in the doldrums. Institutional investors are taking their money out of our system – partly explaining the pace of the peso’s depreciation.

There is no countercyclical policy or program in sight. The convenient explanation for this is that government does not have the fiscal space to counter the trend towards recession – even if seems to have unlimited resources for every sort of subsidy imaginable.

Public relations seems to hold the reins. The administration is chasing after popularity points rather than applying the hard-nosed economics we desperately need at this time.

Popularity is fleeting. Any faction’s political survival is probably meaningless in the end. But the economy is suffering some real damage that becomes harder by the day to reverse.

The corruption scandal has eroded all trust in infrastructure spending. This is unfortunate. Increased public spending on infra is the best countercyclical measure we could do at this time.

The follies of our political elite have a way of undermining the effective governance of this country.

We have thus far borrowed to the gills. Any further borrowing – including floating government bonds at the higher interest rate regime – will suffer punishing rates. Having piled up our debt to subsidize short-term consumption, we are not ideally positioned to use debt to reflate a withering economy.

The obvious argument against a countercyclical policy package at this moment of crisis is that we can no longer afford it. At the minimum, we could not afford such a package at a scale that would matter. We have pushed ourselves to the brink of a debt crisis and therefore could not build the fiscal arsenal necessary to fight recession.

And so here we are, watching the crisis unfold much like we are watching Mount Mayon gathering strength for a major eruption. Which is to say we are basically doing nothing.

In the case of Mayon, there is nothing we can do. Nature has such power we cannot exercise our will over it.

But the economy is not a volcano.