Decomposing the Inflation Dynamics in the Philippines

IMF Working Papers, July 12, 2019

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Inflation rates rose sharply in the Philippines during 2018.
Understanding demand and supply sources of inflation pressures is key to the monetary policy response.
Qualitatively, indicators pointed to inflation pressures from both supply and demand in 2018:
- Supply factors were largely associated with commodity-price shocks.
- Demand factors were inferred from wider non-oil trade deficits seen in the Philippines.
Quantitatively, a semi-structural model was deployed to decompose contributions of various shocks to inflation.

A semi-structural model was used to decompose inflation into contributions from supply and demand shocks and other drivers.
A counterfactual exercise was conducted to assess implications of delayed monetary policy tightening.

Supply factors (mainly global commodity prices) played a prominent role in explaining the rise in inflation in 2018.
Demand factors also contributed to inflation in a non-negligible way, supporting the need for tighter monetary policy in 2018.
The size of the estimated output gap (an important indicator of demand pressures) could be larger when considering the widening trade deficits in 2018.
A delayed monetary policy tightening can be costly:
- It can result in higher inflation rates.
- It may require larger and more aggressive interest rate hikes to bring inflation under control, based on the counterfactual exercise.

Monetary policy tightening in 2018 was justified by the combined role of supply and demand factors.
Early and decisive policy action can reduce the costs associated with stabilizing inflation; delays can necessitate more aggressive interest-rate responses.
Monitoring both global commodity-price developments and domestic demand indicators (including non-oil trade deficits and the output gap) is important for timely policy decisions.

Si Guo, Philippe D Karam, and Jan Vlcek. "Decomposing the Inflation Dynamics in the Philippines", July 12, 2019.