Wednesday, July 3, 2013

Monetary Policy and the Philippine Economy - Dr. John V. C. Nye's Lecture

I am done reading Mises' 4th lecture, inflation, from the book "Economic Policy: Thoughts for Today and Tomorrow". Now, I want to write my own piece combining:

  • Dr. Nye's lecture on quantitative easing, 
  • Summaries of 6 related articles, 
  • Mises' lecture, and 
  • Biblical critique of inflation

But before I do that, I want to share first my understanding of three important terms.

Three Important Terms

I accept the technical difference between inflation and quantitative easing. However, I see them as basically similar for they are both monetary policies and their essence is the increase of money supply.

Inflation has two meanings, the primary and secondary. Its primary meaning is historical. The secondary meaning is popular. Its historical meaning is either an increase in money supply or it includes the act of creating new money, which results into the reduction of the purchasing power of the monetary unit and price increase. The popular meaning is simply confined in price increase.

Considering the primary meaning of inflation, quantitative easing is basically referring to one and the same monetary policy. Mises Wiki helps me clarify the confusion in my mind when it defines quantitative easing as "a euphemism for an inflationary strategy of monetary policy pursued by central banks." So the term is actually a vague substitution for something that is considered harsh, and in this case, the act that is considered harsh is the increase in money supply.

Concerning monetary policy, I restated the definition given by Mises Wiki as the manipulation of money supply advocated by both monetarists and Keynesians through central banks to maintain economic growth and limit unemployment. Only the Austrian school criticizes monetary policy for its destructive results such as the redistribution of wealth, business cycle, and other disastrous economic distortions.

After providing the definitions of the above terms, allow me to proceed to Dr. John V. C. Nye's lecture.

Dr. Nye's Lecture

The academic credentials of Dr. Nye is very impressive. He earned his Ph. D. in Economics from Northwestern University. At present, he is "a Professor of Economics at George Mason University and holds the Frederic Bastiat Chair in Political Economy at the Mercatus Center." He is also "a specialist in economic history..." Interestingly, the problem of economic development in the Philippines is included among his existing numerous projects. 

In presenting Dr. Nye's lecture, I would like to reverse the order by enumerating first the problems and solution he identified in Philippine economy before presenting his positive assessment of quantitative easing.

1. The Problems in Philippine Economy

At the outset, he described the Philippines as "bystanders in the global drama of economic maneuvers" (p.8) and this explains why we are not much affected by global economic crisis. In short, we are not really in the game; we are just watching as the global players battle on the ground. So it is not really true that the fundamentals of Philippine economy is sound that's why we do not suffer as other countries do. Dr. Nye described further the Philippine situation as "non-engagement" (p.9) and lacking in integration with regional and world trade. So the outcome of such position will be protection from trouble and at the same time, from wealth. 

Dr. Nye painted the ugliness of the nation's economic situation. He described the country as the exact opposite of China, which has become "more economically liberal and more business friendly..." (ibid.). The other way of saying it, is that the country is hostile to business initiatives and you can see it through interventionist policies.

Dr. Nye identified numerous problems in the economy, which are "mostly self-imposed" (p.8). In his view, even though the Philippines share some of these problems with neighboring countries, our situation is far more serious. And that's why he thinks that the country has "one of the most distressing climates for investment in the region" (p.10). 

Though there are other problematic areas in the economy like unprepared infrastructure for regional expansion and excesive concentration of industry in the NCR, most descriptions of the nation's economic problems are related to policies and regulations. Below are the descriptions of economic problems that Dr. Nye identified: 

  • "...bad policy and excessive regulation is a breeding ground for corruption and inefficiency that further damages the economy, producing cynicism and complacency" (p.10). 
  • "The PH has a fragmented and poorly integrated economy marked by a dysfunctional state institutions coupled with excessive intervention and regulation" (ibid.). 
  • "Current rules also slow down the development of more advanced urban regions to accept workers who would like to move out of the countryside" (ibid.). 
  • "...while industry is somewhat productive, it is inefficient and hampered in its further development by excessive regulation and high transaction costs" (ibid.). 
  • "Nationalistic rules on ownership and investment limit competition and entrench special interests" (ibid.). 
  • "...among these are the constitutional restrictions on foreign ownership and investment in the Philippines coupled to the mix of bureaucratic red tape, complicated taxes, and petty corruption..." (p.11). 
  • "A crazy patchwork of subsidies, price controls, and regulations give the illusion of helping the poor, while effectively stiffling the economic progress and enriching the corrupt and the politically well connected" (ibid.). 
  • "So many policies in the Philippines seem to be motivated by a nationalism that says it is better to be protectionist and nationalistic even if the end result is greater emigration and lower growth" (ibid.). 
  • "Various reciprocity and tax rules have had the effect of driving foreign air carriers away from the PH thus weakening competition and taxing PH travelers, PH business, and incoming tourists. Taxing foreign businesses with outside options does not harm the foreigners but ourselves" (ibid.).

Dr. Nye summarized our nation's problems in one sentence: 

"PH major problems have less to do with macroeconomic or fiscal stability but with a badly distorted micro-economic price situation, poor and unreliable property rights and contracting, a stiflingly legalistic bureaucracy, a slew of policies and institutional constraints that are anti-investment and anti-competitive, and a political economy that favors the worst mix of populism, elite rent-seeking, and high-minded but unproductive nationalism" (p.13).

2. Solution to Philippine Situation 

Philippine situation is not at all hopeless. It is not yet too late for the country to benefit from what is happening right now in global economy. After reading the entire lecture, I discern that Dr. Nye's proposal though taking into consideration his idea that the country can take advantage of quantitative easing, he believed that the real issue lies in reforming "micro-economic policies to make investment more competitive." (p.8). In order to maximize the benefit of what's going on, the Philippines must act faster than its neighboring countries in reforming its regulations if it does not want to be ignored by foreign investors due to the existence of better options. Moreover, investors must be given the assurance that the changes in policies will stay and remain consistent in the future. If these conditions are not met, our country will once again "look back in a few decades at another set of missed opportunities as the gap with our Asian cousin further widens" (p.13).

3. Positive Assessment of Quantitative Easing

I observe that even Dr. Nye is against interventionism, his monetary ideas are far from the Austrian school and reflect the perspective of Milton Friedman. We can see this in his assessment of the causes of the 2008 crisis, Quantitative Easing, the Federal Reserve, the Great Depression in the 1930s, US economic recovery, and inflation.

Dr. Nye recognized three separate causes of the 2008 global crisis. He did not see the prior increase in the money supply as the primary cause of the crisis. In fact, for him, the greatest mistake of the chairman of Federal Reserve was the hesitation to provide bigger dosage of quantitative easing. He believed that inadequacy of "monetary expansion can make a bad economy much, much worse" (p.1) and "...real crises can be created or worsened by inadequate monetary policy" (p.2). He was actually proposing "...more easing and something that would surpass what had already been tried" (p.3). He is convinced that "...all the evidence is that QE2 was helpful not harmful but that it was inadequate and will require still more intervention" (p.6). Furthermore, he thinks "...that the Fed still has many effective instruments at its disposal..." (ibid.).

The monetary view of Dr. Nye is consistent to Friedmanian analysis of the Great Depression in the 1930's. The major problem then was insufficient liquidity. And also in his view, "...the only policy in the 1930s that helped the recovery was Roosevelt's abandonment of the Gold Standard in 1934" (p.4).

Moreover, for Dr. Nye, US economy has already experienced "notable recovery". He based his idea of recovery on the improved performance of the stock market, rising price levels, and higher GDP.

And finally, his assessment of inflation is also contrary to Austrian analysis. He does not like high inflation, but considers low inflation as an "evidence that we need more not less monetary expansion" (p.6).

4. Personal Comment

Dr. Ron Paul, schooled in Austrian school, diasgrees with Dr. Nye's monetary view. Dr. Nye's interpretation as to the three separate causes of 2008 crisis ignores the critical role of the Fed. For him, the real estate bubble, banking crisis, and macroeconomic collapse had no connection with each other and he failed to see their connection to the action of the Federal Reserve.

In Dr. Paul's congressional report, “The U. S. Dollar and the World Economy” dated September 6, 2001, he argued that the Fed has the primary responsibility for the 2008 crisis and real estate bubble in particular. According to him, it all started with Federal Reserve credit expansion to the tune of $3.2 trillion (Pillars of Prosperity, 2008, p.219). Here is my summary of that connection:

"It all started with Federal Reserve credit expansion. Huge size of the credit went into real estate, stirred up by the '$3.2 trillion of debt maintained by the GSEs' (p. 219). The GSEs by the way, was composed of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. The GSEs received a special treatment through low interest rates and the Federal Reserve monetizing them 'just as if they were U. S. Treasury bills' (p. 220). This action of the Federal Reserve sent an attractive message to foreign central banks causing these banks to purchase great quantity of GSEs."

Ron Paul also contradicted Dr. Nye's idea about quantitative easing. In September 14, 2012, Dr. Paul asserts, “Any further quantitative easing from the Fed, in whatever form, will only make our next economic crash that much more serious.”

These are just two examples where Ron Paul as representative of the Austrian school differed from Dr. Nye's monetary perspective.

However, regardless of Dr. Nye's positive assessment of quantitative easing, which Austrian economists consider erroneous, still he did not believe that quantitative easing as far as the Philippine economy is concerned would greatly benefit the country without consistent adjustment in micro-economic regulations. QE does not create growth and has little effect on local economy. For him, even increase in tax revenues is incapable to improve the economy without regulatory reforms. He saw the primary function of monetary policy as "a means to smooth out short term fluctuations and provide the proper background conditions to support development" (p.8). He added, "The purpose of monetary policy should be to allow the real economy to perform better" (ibid.).