Tag Archives: monetary policy

Fed Policy Recommendation Continues

In his Monday’s article on Wall Street Journal, Martin Feldsetin writes about how the Fed isn’t showing its strategy if sudden inflation surge comes when the economy gets fully out of the recovery. Feldstein, a professor of economics at Harvard and a former chairman of Council of Economics Advisors under Raegan, is known for being inflation hawk all the way back to 2009. According to him, Fed policymakers should inform about what they can do with their monetary tools if there ever will be an inflation hike in the process of the recovery in their guidance statement. He then explains possible monetary tools the Fed can utilize to fight against inflation. His recommendation includes increasing fed funds rate, increasing interest rate on reserves,  using reverse repurchase program and increasing required reserve in the banks. He believes all of this policies may not be sufficient or politically possible task to do for the Fed.

Then Paul Krugman mocks Feldstein’s being pre-hawkish on his Tuesday blog post.  Krugmans sums up Feldstein’s article in the post:

 The point is that this has to be one of the weakest policy arguments I’ve ever seen: Arguing that the Fed should shy away from doing all it can to create jobs because you’re afraid that at some point in the future Fed officials will be insufficiently hawkish because they’re afraid that people will make fun of them.

To me, Krugman clearly doesn’t see the main point of Feldstein’s article. Feldstein says simply that the Fed should be saying what it will be doing if inflation comes from let’s say nowhere. But Krugman interprets it as Feldstein was being hawkish and recommending the Fed to stop expansionary monetary policy as soon as possible.

Feldstein’s recommendation that the Fed should be guiding the market on what it will and can do under the pressure of inflationary period is interesting and actually might be good add-on to their forward guidance for the Fed policymakers because:  by simply reminding the market that there still could be some possibility of inflation hike (however small this possibility is) and showing off their guns and ammo for inflation hike, the Fed could raise public’s inflation expectation.

If the Fed does what Feldstein suggest and includes possibility of higher inflation, the market’s inflation expectation can be shifted because of the Fed’s being pre-hawkish. Increasing market inflation expectation is exactly what the Fed has to do right now when PCE inflation index has been under the Fed’s inflation target of 2 percent for 21 straight months. Moreover, the current doubt that the Fed might be targeting 2 percent inflation as an upper limit for the target, not target, could be cleared if the Fed leaves some room for inflation raise possibility on its statement.

 

Japan’s increase in sales tax – right decision?

In my previous blog post Japanese economic growth – now time to stimulate export, I wrote about how Abenomics has not been successfully increasing the Japanese export. Furthermore, I was concerned about Japanese economic recovery, as Japan’s recovery is mainly driven from increase in domestic consumption. In April 1st 2014, Japan’s domestic sales tax rose from 5% to 8%, as forecasted in October 2013. Japan’s Prime minister Abe Shinzo’s aggressive monetary policy did help Japan to escape from its continuing deflation, and I am worried if this rise in sales tax will go against Abe’s monetary policy.

According to the Wall Street Journal article Japan’s Sales-Tax Boost Will Test Abenomics, Japanese government’s decision to increase sales tax worries many economists. As it can be seen from the graph below, Japan have once increased its sales tax in 1997 from 3% to 5%. The result was disappointing, as Japan suffered from a decrease in consumption and continuing deflation and recession for more than 18 months. Bank of Japan forecasts that Japan’s Consumer Price Index will be at its steady rise of 1.3% for remainder of 2014 and then reach its target rate of 2.0% by 2015, while private economists forecast that Japan might go back to its long-time deflation, with rate lower than 1%.

EI-CG569_OUTLOO_G_20140330160004

The article from Reuters Abe bets he can break Japan sales tax jinx with April 1 rise points out that the main reason for this increase in sales tax is to curb Japan’s massive public debt. Jesper Kroll, head of equities research at JP Morgan insists that “2014 is not 1997”, saying the probability of success (in rising sales tax) is better than ever. He cited a tight labor market, increased household and small-business burrowing and a $53.44 billion extra budget enacted in last December will cushion the impact of the sales tax rise.

However, I am still concerned about this tax rise. As I have already mentioned in my previous blog post Japanese economic growth – now time to stimulate export, Japan’s economic recovery in 2013 was driven from domestic consumption (not international trade) despite aggressive Abenomics. While Yen is still strong, Japan’s export is unlikely to boost in a huge amount in 2014 as well. Therefore, if Japan’s domestic consumption is reduced due to an increase in sales tax, then it is probable that Japan will be unable to maintain the fast rate of economic recovery from 2013. Therefore, I think it is extremely important for Japanese government to keep an eye on Japanese economy (especially its domestic consumption and CPI index) and execute necessary monetary and fiscal policies if increase in sales tax goes to an opposite direction to where Abenomics is heading.

(Revised) Fed Keeps Steady Policy Course

In the past months, the Federal Reserve has executed a steady tapering in their purchases of  long-term treasury bill and mortgage backed securities, although not without opponents.  As expected, the Fed voted in January to reduce the QE scheme from $75 billion to $65 billion in purchases, in the midst of slumping developing markets, and the exchange rates of many foreign currencies fell in response to changing expectations in the domestic market.  As U.S. investors saw potential for higher U.S. returns as government demand for T-bills decreased, they pulled funds out of foreign markets, causing net capital outflows and the weakened currencies in those markets.

By continuing with the intended tapering policy, the Fed made a decision not to consider the potential adverse effects of their decision on foreign markets.  In fact, “Fed officials made no mention of these trends in the statement released [in January].”  In recent years, this has been the general strategy of the Fed, with chairman Ben Bernanke stating in 2011, “It’s really up to emerging markets to find appropriate tools to balance their own growth.”  Foreign central banks took this policy to heart in January, with the Turkish central bank raising it’s overnight lending rate over 400 basis points , and other small central banks enacting similar policies.  While their policies weren’t very effective, these emerging markets clearly understand that the U.S. will not shape their policy to accommodate them.

At the March FOMC meeting, the Fed stuck to it’s stated plan, further tapering purchases from $65 billion to $55 billion in the coming months.  Perhaps the key feature of the March statement was the change in language about when the federal funds rate would start to rise.  No longer was the the federal funds rate to float between 0 and 25 basis points, “at least as long as the unemployment rate remains above 6-1/2 percent” as in the January press release. Instead, the March statement stated rates will remain low, “for a considerable time after the asset purchase program ends”.

 

fredgraph

This key feature highlights the Feds respect and compliance with their dual mandate to both keep inflation and employment at their natural levels.  The March statement cuts the tie between unemployment and the federal funds rate.  As Chairwomen Yellen has mentioned recently, the labor market is still weak, and has much room to improve despite the increase in employment.  The graphic illustrates how unemployment has dropped, but along with it labor force participation as well.  These facts, coupled with the increase in workers only able to find part time employment skew the actual health of the economy, and thus why the Fed has stepped away from using unemployment as a measure for the economy as a whole.

fedholdingscpi

Although the Fed has seemingly deviated from past statements, the policy actions are consistent with their overall mandates.  The Fed initially chose a 6.5% unemployment number to try and avoid overheating the economy and driving inflation up.  However, this is no concern, because inflation has actually been far lower than desired in recent years, hovering between one and one and a half percent, despite the influx of money into the economy by way of the present quantitative easing.

I believe that the Fed has made the correct decision not to react to the fluctuations in the foreign markets or faulty economic data in their recent policy decisions. The Fed has recently show discipline not to venture from solid fundamentals and also to be willing to adjust expectations to what is best for the economy.  Although unheralded, the Fed has been key in propelling the economy towards recovery and stability, and has probably save tens or hundreds of thousands of jobs.

Fed, Raise the Inflation Target

Friday’s report of the personal consumption expenditure price index, which the Fed prefers, shows that year-to-year price index grew by 0.9% in February. This means that the inflation rate has been below the Fed’s target of 2 percent inflation rate for 21 consecutive months.

While this low inflation rate has been allowing the Fed to pursue its quantitative easing program and low interest rate policy , the Fed policy makers also know that higher inflation rate around their target of 2 percent would make their job easier, simply lowering the real interest rate. But it seems like the Fed has been short of achieving its “target” for 21 months. A question we should ask from ourselves is that: is the Fed unable to hit its target? or is the Fed actually targeting lower than their so-called “target”. In my Monday’s post, I made a case for the second question getting an answer “yes!”. If the Fed is indeed targeting inflation rate lower than its 2 percent “target”, the points following are useless since the Fed policymakers want low inflation anyways.

Now if we are in the world where the Fed has actually been unable to hit its inflation “target” given that it wants to hit it so badly, my policy prescription for the Fed is to increase its inflation target from 2 percent to 3 percent or somewhere around that for the duration of the recovery. Note that, I am not suggesting to raise inflation target to 4 percent or other for the long-run as Laurence Ball and Olivier Blanchard suggested, but to raise it until the economy recovers.

The Fed could target this higher inflation rate by declaring in its meeting statements that the Fed will be comfortable with inflation rate considerably higher than 2 percent when deciding when to raise the fed funds rate. Let’s look at the Fed’s latest statement:

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.”

The Fed, in my policy prescription, should change “run below the Committee’s 2 percent longer-run goal” to “run below 3 percent” (or some rate around that). That change should have positive effect on inflation expectation. If the Fed believes the inflation expectation hasn’t been responsive to its inflation rate target, that is great for the Fed since it could further state higher inflation target such as 4 percent to raise the expectation more while not actually raising the inflation higher.

But again, raising inflation target makes sense to me if the Fed does want to raise the inflation expectation. But considering its tapering QE even though their desired 2 percent inflation isn’t seen to be reached for some time, I am puzzled by what inflation rate the Fed wants. Or are the Fed policymakers actually buying Stephen Williamson’s paper?

FED renews focus on its duel mandate

Wednesday, the FED dropped the unemployment rate as a benchmark for when to raise the federal funds rate.  It has hinted at doing this for since January, since the indicator has been decreasing due to discouraged workers dropping out of the workforce as opposed to being hired.  In its place, the FED has said it will use a more comprehensive approach, as it seeks to continue its accommodating monetary policy until inflation becomes a problem or employment picks up.

Not everyone shares this opinion, not even on the Board of Governors.  The president of the Minneapolis Federal Reserve Bank, Narayana Kocherlakota, was the lone dissenter in this past weeks FOMC meeting.  While he argues the new policy will lead to uncertainty, I question the viability of his alternative.

Central to his disagreement is the ambiguous nature of the FED’s guidance with respect to he interest rate going forward. Mr. Kocherlakota thinks that without a firm number to track, the FED’s commitment to its message won’t be taken seriously.  However, the FED has had to move its previous number (6.5% unemployment rate) because it was about to be realized, and the FED would like to see the economy closer to full employment before rates increase.  If the conviction of the FED rested on a deterministic number, then picking another on may seem as arbitrary as the first.

As an alternative, he suggests lowering the unemployment number to 5.5%, to provide a more determined target.  I feel that there is a problem with this.  Using data series from FRED, one of which is graphed below, it can be seen that the natural rate of unemployment in the short and long term is at or above 5.5% for the foreseeable future.  Using it as a guide provides no valuable information since one would think that the FED would try to step off the zero lower bound if the United States was at the natural rate of employment.  The FED needs a different metric in order to give it the leeway it needs.

alfredgraph

If a policy with a firm benchmark is desired to insure credibility and confidence, instead of the unemployment rate why not use inflation as a guide?  While some have argued to raise the target inflation, there are very rational reasons for why 2% was chosen, and nothing so extreme is needed.  Instead, the FED should say that the central bank will do what it feels is prudent to foster a return to the natural level of output while inflation remains below the targeted levels.

I feel that Inflation will play a central role in the FED’s decision to raise interest rates, whether it wants to put a number to it or not.  With inflation at its current levels, the FED has the price stability it needs.  Provided this price stability remains, the FED should do all it can to stimulate employment.  While a firm number would bestow confidence in markets, it can also cause exactly what we are seeing now when the economy reaches predetermined levels in unanticipated ways.  Based on past results, the United States should have a little more confidence in its Central Bank to handle its business.

Looking for MP curve

While I read “On the Great Recession”, one of Professor Kimball’s blog posts, I think that KE-MP model can more accurately explain developments of the Great Recession and effects of possible policy measures to address the Great Recession. I think this explanatory advantage mainly comes from the fact that KE curve is derived from microeconomic basis and can effectively incorporate changes of risk premiums in the economy. MP curve, which represents central bank’s policy reactions, seems to be identical to that of traditional IS-LM model. And I feel that I want to find some real world evidence of existence of KE-MP curve by myself though it is quite simple and rough.

First, I try to draw the MP curve, which shows relationship between economic status and FRB’s monetary policy reactions of changing interest rates. For economic status, I choose the spread between natural rate of unemployment and unemployment rate. When this spread is positive, unemployment level is below natural rate of unemployment. This can be interpreted as economy is in kind of boom. In the other hand, when this spread is negative, unemployment level is above natural rate of unemployment. This can be interpreted as economy is in kind of recession. For FRB’s policy reaction, I choose the spread between Aaa corporate bond yield and federal funds rates. In the short run, inflation expectation is sticky, and change of nominal interest rates can be regarded as change of real interest rates. When the economy is in boom, FRB is likely to aggressively raise the federal funds rates to cool down overstimulated economy. By doing so, the spread between Aaa corporate bond yield and federal funds rates is likely to decrease. In the other hand, when the economy is in recession,  FRB will likely to aggressively lower the federal funds rates to boost economy. This will lead to increase of the spread between Aaa corporate bond yield and federal funds rates. So, those two spread should have some negative correlation with each other along with economic boom and recession.

corporate bond and unemployment

As can be seen in the graph, there is clearly negative relationship between two spreads. For example, during the Great Recession, the spread between natural rate of unemployment and unemployment rate droppred greatly showing economic recession while the spread between Aaa corporate bond yield and federal funds rates increased greatly showing FRB’s lowering federal funds rates almost to zero.

Interestingly, compared to magnitude of decrease of the spread between natural rate of unemployment and unemployment rate, magnitude of the spread between Aaa corporate bond yield and federal funds rates is not so changeable. This means that, even though the Great Recession more seriously hurt economy, FRB’s policy action is not so different from the policy reactions in other economic downturns. I think this shows the Zero Lower Bound limitation of FRB’s policy reaction. If the FRB can maneuver the Fedreal Funds rates below zero, this policy action spread between Aaa corporate bond yield and federal funds rates  in the Great Recession should be much greater than other economic downturns, and FRB possibly achieved more rapid economic recovery. Though this graph is basic and simple, and doesn’t show some nice looking upward slope shape between output and real interest rates. We can see existence of MP curve from the real world examples, which is policy reaction of central banks. Next time I will try to find some real world example of KE curve, which is main characteristics of KE-MP model.

 

(Revised) Making different voices in the Fed

As the FOMC decided to keep gradually tapering its bond buying programs, there are many reports about this widely expected monetary policy decision. What interests me is that some high rank officials like Richard Fisher, President of Dallas Fed, are making different voices publically from the FOMC’s decision. He has continuously argued for quick end of the bond buying program. Here I want to talk about two things: one is about publically making different voices in the Fed, and the other is Fisher’s argument for bond buying program.

It is known that the former chairman, Ben Bernanke, is more tolerant of different opinions in the Fed than other former the Chairmen like Greenspan and Volcker. Yes, in this democratic world, everyone can make her own decision, and it is universal and unalienable right to express her opinion freely without any restrictions. But what about making different voices publically in policy institutions like the Fed. Doesn’t it cause any confusion in the markets and businesses? Doesn’t it reduce the policy effectiveness of the Fed whose monetary policy is heavily dependent on effective communication of its policy intentions to the public?

I believe that having a different opinion and a vigorous discussion process is necessary to achieve desirable decisions. But I also think that these contentious discussions need to be limited in the  policy making process. After making decisions, isn’t it more desirable to have one voice for implementing policies? Let’s imagine an extreme situation. Before battle, should generals, for example, decide their battle strategies, there should be vigorous discussions and harsh criticisms about weaknesses and strengths of potential strategic options. But once the battle strategy is decided, it may be best to follow the strategy in one voice to increase the effectiveness of the strategy and the chance of winning. If each general keeps criticizing the decision publically to soldiers, the army will be divided and soldiers may fall into confusion. The chances of winning the battle may decrease seriously.

Surely a military example may not be comparable to the Fed monetary policy decision. But, I am more inclined to think that it may be more beneficial to have one voice about monetary policy decisions within the Fed. I think that public critique for the Fed policy is responsibilities more of academics, news media, and politicians, not of the Fed officials.

Another issue is about Fisher’s argument. Fisher argues that quantitative easing policy induces financial investors to take more risks possibly causing another financial crisis. This is very similar to one of the John Talyor’s argument that low interest rate works as a fuel for speculation. I cannot say that his argument is totally wrong. But, as Professor Kimball pointed out, Fisher’s claim is not plausible without some combination of investor ignorance and irrationality. We cannot see how the claim could hold in a model with rational agents and no fraud.

I think that the quantitative easing policy is one of the policy measures to address the unreasonably increased risk premium. Due to the serious credit events like the collapse of the Lehman Brothers, risk premium greatly increased in the financial markets, resulting in rapid down shift of the KE curve. In this economic crisis, the quantitative easing is a reasonable policy response to move MP curve outward, and also to raise KE curve by contributing to recovery of  investor’ confidence. This is well explained in one of Professor Kimball blogs. Specifically, I think this upward shift of KE curve partly caused by quantitative easing is not the result of irrational increase of risk taking, but is the process of normalization of risk perception in the financial markets.

BAA10Y_Max_630_378

And as we can see from the spread between Moody’s Seasoned Baa Corporate Bond and 10-Year Treasury Constant Maturity, which is likely to widen as the risk premium increases, we can still observe that the spread is still way above pre-crisis level and maintains generally higher level compared to other times. This means that there is still higher risk premium in the financial markets. So, we cannot see any evidence supporting Fisher’s argument of this irrational movement of investors from both theoretical and practical perspectives.

Surely, Ben Bernanke left many things to think about even the communication Strategy. I think that Janet Yellen  needs to address this issue of publication of disagreement within the Fed for more effective monetary policy implementation.

 

February Employment Report: Implications for Monetary Policy

During her inaugural public appearance since becoming chairwoman, Janet Yellen confirmed that her intention is to continue the policies of her predecessor Ben Bernanke. As the economy improves, Yellen intends to slowly wind down the large-scale asset purchases – also referred to as quantitative easing (QE). I believe the February employment report provides data to confirm this plan, however, constructing forward guidance will still be a challenge.

The February employment report was released on Friday, March 7th and showed positive signs about the economic recovery. According to the Wall Street Journal, “Nonfarm payrolls grew by a seasonally adjusted 175,000 in February, the Labor Department said Friday, following a two month stretch of weaker growth. The unemployment rate ticked up to 6.7%, in part because more people joined the workforce”. Although the unemployment rate increased, it increased for all the right reasons. In this case, the rise in the unemployment rate reflects a rise in the labor force participation rate – a sign that conditions are improving in the labor market. As sentiment about the labor market improves, people are choosing to return to the labor force and pursue jobs. In addition, the increase 175,000 jobs added beat expectations and was more than the previous month – indicating that adverse weather likely depressed previous employment reports this winter. I speculate that the strong February employment report will encourage the Federal Reserve (Fed) to continue tapering.

I believe the Fed might find this an opportune time to adjust forward guidance, but I am not sure how they will do it. According to the Wall Street Journal, “A more vexing challenge for the Fed will be fine-tuning its official policy statement, which is loaded with assurances of low-interest rates in the future”. With the exception of the February employment report, the unemployment rate has been falling consistently. The Fed has already stated that it intends to keep rates low even after the unemployment rate falls below the 6.5% threshold. As I have mentioned before, the Fed might want to consider nominal gross domestic product (GDP) targeting.

However, I do not expect the Fed to announce nominal GDP targeting because it would be too much of a surprise. The Fed’s dual mandate includes unemployment and inflation, which means these two indicators will remain important (perhaps this can be legally changed one day). According to the Wall Street Journal, “[Janet Yellen] and other top officials have suggested a new statement could emphasize the Fed’s interest in a broad array of indicators, rather than a single unemployment indicator”.  Although I do not know what array of indicators they will choose, I believe this is a good first step. I think it would make sense for Yellen to choose a large selection of indicators that provide a sense of financial stability. Financial stability should be an explicit factor for interest rate decisions. Regardless of what indicators Yellen mentions, I am sure she will state that interest rates will stay low for awhile.

Although the economic recovery has been disappointingly slow, the economic outlook is undeniably improving as confirmed by the February employment report. Reducing asset purchases to $55 billion per month should be a clear decision, however, adjusting forward guidance poses more issues.

Increase of Wealth Inequality

U.S. households’ wealth increased to the highest level last year. The Wall Street Journal reported that the net worth of the U.S. households and nonprofit organizations increased 14% in 2013, almost $10 trillion. Their total value reached to $80.7 trillion. This rapid increase of wealth can be interpreted as the sign of the strong recovery of the U.S. economy. But, be careful, the Wall Street Journal also reported that inequality of wealth becomes more severe, as wealth increases, and the increase of the wealth does not seemed connected to increase of consumption.

Rapid increase of last year’s wealth mainly resulted from stock markets boom. Standard & Poor’s 500-stock index soared 30% last year. The rich are more likely to own stocks and benefited mostly from stock price increase. Another interesting fact about wealth inequality is that old generation gets richer whereas younger generation lags behind in the wealth increase.

I think that this disproportionate increase of wealth among income classes and generations may hinder economic growth because those who are rich and old are more likely to save more than spend. If the increase of wealth is more wide spread among various income levels, this increase of wealth may have contributed to more rapid recovery of the economy. No one will disagree that the balanced growth of income among different income levels are more preferable than widening gap of wealth and income inequalities.

These differentiated income and wealth growth among economic classes makes the Fed’s decision of monetary policy more difficult because monetary policy cannot be implemented differently to address each economic group’s interest: rich and low, middle income families, and young and old generations. As stock markets and housing prices increase, the Fed may worry about another accumulation of bubble in the asset markets. To address this rapid increase of asset prices, the Fed may need to tighten its monetary policy, but this may severely impair the recovery of middle and low income families’ economic situations. So, this divergence of wealth growths and income distributions can make it hard for the Fed to interpret overall economic situations.

For the issue of equalities, I think that fiscal policy is more effective than monetary policy because fiscal policy can be used for more micro economic purpose of income distributions than monetary policy. And I guess that’s one of the reasons why Obama administration recently more emphasizes equality issue. This is also big challenge for the government because the government usually needs to collect more taxes from the rich and transfer wealth to the poor in order to enhance income equalities.

According to some extreme calculation done by Mr. Hodge, president of the Tax Foundation, government needs to redistribute nearly $4 trillion from the rich to give average income for all americans. However, if taxes are increased beyond certain level, this will hamper economic incentives for the rich making fiscal policy less effective and hurting economic growth. This is explained by the laffer curve, which shows that as the tax rate for the rich increases over certain point, there is more likely to actually decrease government revenues. So, the issue of widening gap of wealth and income inequalities makes economic policies more difficult, and asks more cautious and balanced approaches for both the rich and the poor.

Philippine’s inflation and economic growth

In my previous blog post (Monetary policies in Asian Countries), I compared monetary policies among different Asian countries. Philippines was an interesting country to note, as it had strong economic growth rate of 7.2% in 2013, which is greater than the government’s target of 6.0% to 7.0%. Its natural disasters-earthquake in October 2013, typhoon in November 2013 and massive flood in January 2014, all became a trigger that initiated construction sector of Philippines economy and thus boosted the economic growth. Furthermore, according to Wall Street Journal article (Philippines GDP Surges Despite Disasters), the inflation rate was around 4.1% year over year in December and average full year was 3%, which is on the government’s target range of 3% to 5%.

Philippines’ February inflation came out recently. According to Wall Street Journal article (Slower Inflation Gives Philippine Central Bank Reprieve ), pace of Philippine’s inflation in February dropped so central bank can continue to keep its interest rate constant for now. February’s inflation based on consumer price index was 4.1%, 0.1% lower than 26-month high of 4.2% in January and still slightly below expectation. Core inflation, excluding some food and energy items, decelerated to 3.0% from January’s 3.2%. It is significant as this decrease in inflation rate denotes that Philippine’s high inflation rate was mainly due to supply shocks caused by November’s Typhoon Haiyan and other natural disasters including flood and earthquake.

It is a good news for Philippines. As inflation rate decreases Philippines’ central bank can keep its relatively low interest rate, and continue to stimulate its high economic growth. Many economists suggest that the central bank will keep its interest rate until third quarter of 2014, and then it may consider increasing the interest rate if the inflation rate for next three months continue to be above 4.0%.

Personally, I predict the inflation rate will decrease in next three months. The supply shock from natural disasters was a main reason for Philippines’ high inflation rate, and this supply shock is being resolved as previous article suggests. If this prediction is true, central bank can keep its inflation rate to keep its high economic growth. Philippines’ high economic growth was partially due to reconstruction after natural disasters. As reconstruction is one time effect, Philippines cannot guarantee its high economic growth in upcoming quarters. Therefore, I think it is extremely important to observe its inflation rate and try its best to keep its loose monetary policy to continue its high economic growth. I predict that Philippines’ inflation rate will decrease in upcoming quarters, thus able to keep its high economic growth by keeping its interest rate.