Every single unit of government spending is paid by you, with more taxes, more inflation or both. All government excess makes you poorer. The government does not give you free money, it gives you expensive destruction of your options for a better future—Daniel Lacalle
In this issue:
Justifying Record Deficit Spending Through the BSP’s "Plausible Deniability" of Demand Side Inflation
I. Demonstrated Preference Exposes the "Plausible Deniability" of Demand Side Inflation
II. The BSP’s "Plausible Deniability": Justifying Record Deficit Spending
III. Near Record Fiscal Deficit from Historic Public Spending
IV. How Deficit Spending Affects Street Prices and Inflation
V. Public Spending Bonanza: Why Kill The Proverbial Goose That Lays The Political-Economic Golden Egg?
VI. Ignoring the Risks of Debt and Inflation Financed Excessive Spending
Justifying Record Deficit Spending Through the BSP’s "Plausible Deniability" of Demand Side Inflation
The BSP seems to employ "plausible deniability" in addressing the roots of inflation. It proposes "supply shocks" as its primary cause to deflect the role of the money-driven demand side. In so doing, it protects the political imperative of deficit spending.
I. Demonstrated Preference Exposes the "Plausible Deniability" of Demand Side Inflation
A week before the announcement of the November CPI, this revealing excerpt from a November speech by the BSP chief showcases their blanket denial of responsibility.
The most important pillar, I think, is price stability, which is, right now, very simple to explain: keeping inflation between 2.0–4.0 percent. For this year, we will clearly miss the target. And as we will explain, we will miss the inflation target because the high inflation is due to what we call "supply shocks," which is not our accountability. In other words, if inflation is too high because we [at the central bank] created too much demand, we created too much credit, too much money, then blame it on us. But the [current elevated] inflation is due to shocks that have little to do with demand but have more to do with supply. Clearly, central banks cannot control them. (Medalla, 2022) [bold mine]
But even then, demand-curtailing policies had to be used.
What have we done? We have raised interest rates. But fortunately, we seem to be right that high interest rates will not kill the economy. And then, we hope that with the interest rate adjustments, inflation will come back to normal by the middle of next year, unless there are new supply shocks, new surprises. And then by 2024, hopefully, we will be back to normal inflation rates again.
This comment is striking because of the sweeping assumption of demand "inelasticity" while dismissing the role of money injections and credit expansion in forging or shaping economic imbalances.
The BSP chief depicts a world of abundance abruptly shattered by supply dislocations.
And because of "inelastic demand," money supply conditions have little influence or connection with the diffusion of increases in the prices of goods and services. It is as if money prices and money exists in a separate world!
And also because of the alleged "rigidity" of the marketplace, addressing inflation is a task exclusively of central authorities.
And yet, ironically, the BSP takes corrective actions by controlling the money supply through curtailing credit expansion via unprecedented hikes in its policy interest rates and a partial pullback in its monetization of public debt!
The actions of the BSP incredibly disprove their assertions: actions speak louder than words! Or the demonstrated preferences have exposed the tenuous foundations of the political PR stratagem of "plausible deniability."
Plausible deniability, according to Wikipedia, is the ability of people, typically senior officials in a formal or informal chain of command, to deny knowledge of or responsibility for any damnable actions committed by members of their organizational hierarchy.
And there's more.
Monetary, financial, and political authorities have not foreseen this inflationary crisis and even misdiagnosed its causes. Then why should we expect a Panglossian outcome when impulse rather than calculated probabilistic responses seem to have shaped their historic decisions?
Differently put, the BSP has a scant idea of the intricately intertwined feedback loops or the complex ramifications of their actions.
And for such reasons, hope transforms into a determinant of policy payoffs. We should believe that they will attain their goals because they say so. Period.
But hope is not a strategy.
II. The BSP’s "Plausible Deniability": Justifying Record Deficit Spending
Of course, ideology and politics play a role in the "plausible deniability" of the monetary origins of inflation.
In the ideology of the economics of "borrowing to spend your way to prosperity," deficit spending represents an integral role.
In theory, if the private sector isn't spending enough, it is the government's function to take its place.
In practice, government spending is key to consolidating and expanding social, political, and economic power, hence its preference for the powers that be.
But again, in their attempt to educate the public, the primer of the BSP presents inflation in a different light, contradicting the current position of their leaders. (bold added)
Fiscal deficit: When the government spends a lot more than it collects.
Demand for loans: There is a stronger demand to finance the gap in the budget.
Lending rate: This exerts upward pressure on domestic interest rates, particularly if the government borrows from a less relatively liquid domestic market.
And a recent article from the IMF blog has underpinned such a thesis.
A smaller deficit cools aggregate demand and inflation, so the central bank doesn’t need to raise rates as much. Moreover, with global financial conditions constraining budgets, and public debt ratios above pre-pandemic levels, reducing deficits also addresses debt vulnerabilities.
Conversely, fiscal stimulus in the current high inflation environment would force central banks to slam on the brakes harder to curb inflation. Amid elevated public and private sector debt, this may raise risks for the financial system, as our Global Financial Stability Report described in October. (Tobias and Gaspar, 2022)
How big are such risks? The BSP doesn't seem to know.
But in the case of the monetary captains, their bias seems aligned with the executive branch, where deficit spending represents the primary political-economic priority.
Businessworld, November 25: The National Government’s budget deficit ballooned to P99.1 billion in October, as state spending outpaced revenue collections, the Bureau of the Treasury (BTr) reported on Friday. In its latest cash operations report, the BTr said the October budget gap rose by 54.08% from the P64.3 billion deficit in the same month a year ago. “The higher deficit for the period resulted from the year-over-year acceleration in government spending outpacing revenue growth,” it said in a statement.
That is to say, to justify deficit spending requires the plausible deniability of demand-side inflation.
III. Near Record Fiscal Deficit from Historic Public Spending
A fiscal deficit means that the government spends more than it collects.
But statistics can mislead. Occasionally, the media reports that revenues have risen faster in a given period. But the reference to the % rate of change primarily stems from the base effects.
In the ten months of the year, although revenues and spending in peso have trodden on uncharted territories, the government continues to spend more than it collects. As such, the 2022 YTD fiscal deficit of Php 1.112 trillion was just off by 7.6% or by a meager Php 91.55 billion from last year's all-time high of Php 1.203 trillion. (Figure 1, highest pane)
It goes to show that the 2022 deficit might even surpass last year's record.
That is conditional on whether public spending outperforms, collections underperform, or both in the last two months compared to 2021.
And though the rate of YTD (10-month) public outlays has slowed compared to the last two years, it is just off 13.2% or Php 618 billion from the 2021 annual spending of Php 4.676 trillion. And at the current monthly average of Php 406 billion, this year's annual performance looks likely to surpass 2021! (Figure 1, middle window)
Since expenditures are programmed, revenues will likely determine 2022's fiscal outcome.
By month, the widening gap between spending and revenues in pesos, expressed by their respective exponential trends, demonstrates the trajectory dynamics of fiscal deficits. (Figure 1, lowest pane)
IV. How Deficit Spending Affects Street Prices and Inflation
Government spending involves the use of finite resources and financials.
It also competes and crowds out its private-sector counterparts. That being the case, the impact of public spending on the economy affects market prices, thereby, inflation.
If financed solely by taxes, government spending is not inflationary. But public outlays becomes inflationary when funded by monetary expansion from banks and the central bank.
Figure 2
Financing the record streak of deficits initially involved the banking system. The BSP's role became apparent when it used the pandemic as a pretext to announce the historic liquidity infusion into the banking system in 2020. (Figure 2, topmost pane)
Pressing onward anyway, though M3 has lately underperformed in %, it is a different story in pesos. There is a significant correlation between public spending and money supply (M3). That is, the record streak in public expenditures has mirrored the record surge of M3. (Figure 2 middle window)
And in so being, the accelerating uptrend of the CPI has resonated with public spending. (Figure 2, lowest pane)
That is to say, demand from public expenditures plays a crucial role in the CPI.
But here’s the thing.
Why should we expect price pressures to decline when contemporary politics dictates the use of sustained aggressive deficit spending to attain the goals of political-economic centralization?
And so, why do you think the BSP would frontally admit to this?
Why contain the ideological propensity to borrow and spend when authorities can pass the blame on exogenous factors? Why would they not divert the public's attention toward the "supply shocks" instead? Because it is "independent" of politics?
If they prioritized "price stability," then why this inflation crisis?
V. Public Spending Bonanza: Why Kill The Proverbial Goose That Lays The Political-Economic Golden Egg?
The BSP appears to be patronizing popular politics for its mandates.
Political authorities have benefited immensely from the inflation-boosted ramping up of taxes and the headline GDP.
Figure 3
For instance, the ten-month tax revenue growth rate of 17.6% represents the fastest since 2012. (Figure 3, topmost pane)
The BIR collection, which bolstered tax revenues, expanded by 12.6%, which accounted for the best rate since 2014. The CPI has boosted BIR collections through sales and excise taxes. The higher the prices, the more the collections. (Figure 3, second to the highest window)
On the other hand, the expansion of cash in circulation appears to have financed the recent growth spikes in local government allotments on the 2022 election spending and the implementation of the Mandanas ruling. (Figure 3, second to the lowest pane)
Aside from elevating spending and collection, the growth in the % share of direct public spending has been instrumental to the national GDP! (Figure 3, lowest window)
Direct public spending has reached the highest share of GDP ever! More and more resources have been shanghaied for political consumption! And such data excludes the indirect role performed by the private sector allocations to political projects.
So why kill the proverbial goose that lays the political-economic golden egg?
VI. Ignoring the Risks of Debt and Inflation Financed Excessive Spending
But the BSP appears to ignore or dismiss the risks of such an untenable relationship.
Authorities have yet to publish the updated status of public debt this October. Nonetheless, to be eclipsed soon is the Php 13.5 trillion debt last September, which was an all-time high.
Of course, another benefit of government-sponsored inflationary policies is their ability to inflate away this mountain of debt.
In any case, despite the so-called dispersion of debt tilted towards the long-term, new debt issuance and rollovers of maturing debt have sent an upward streak in interest payments. (Figure 4, highest pane)
As an aside, the distribution of public debt is never static. It is a product of human action through public treasury management. In the recent case of banks, the latest surge in T-bills for funding purposes demonstrates sudden reactionary adjustments according to momentary liquidity requirements.
Back to our discussion.
And though the % share of interest payments remains stable, this has been due to the more significant pace of expansion of the other aspects of public outlays.
And higher rates have yet to make an impact on the economy.
Further, soaring public expenditures have taken their toll on the momentum of M2 deposits, which growth rate remains on a long-term downtrend. (Figure 4, second to the highest window)
As the BSP primer noted above, higher rates are required when deficit financing competes with the private sector in a less liquid domestic market.
Cascading growth rate of cash in circulation and M2 savings deposits are symptoms of a "less relatively liquid domestic market." (Figure 4, second to the lowest window)
Worst, even as the economy reported a dazzling 7.6% GDP in Q3, according to the CEIC data, gross savings fell to the second lowest in history! (Figure 4, lowest window)
The takeaway. Though excessive spending has boosted the headline GDP, not only has it been eroding the corn seeds of productivity through malinvestments and inflation but also amplifying the various risks associated with over-dependence on leverage.
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References
Medalla, Felipe M. (2022, November 10), "Exploring greater participation from actuaries in the evolving capital markets," speech at the Actuarial Society of the Philippines (ASP) 63rd Annual Convention, Manila. BIS.org
Adrian, Tobias and Gaspar, Vitor "How Fiscal Restraint Can Help Fight Inflation," November 21, 2022, IMF Blog
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