EFFICIENCY OF FISCAL AND MONETARY

POLICIES IN THE PHILIPPINES:

THE ST. LOUIS MODEL APPROACH 1
Neil Angelo C. Halcon
Leah Melissa T. De Leon

Introduction experience, made monetarists confront the issues of

credibility and sustainability among decision-makers.

D ebates have persisted around what policy is

deemed effective in stimulating as well as in
stabilizing growth in the Philippines. Over time, the
Expectations. The monetarist theoretical
scenario has a strong policy message. The existence
interactions of both fiscal and monetary policies have of an “expectations component” in the argument
largely depended on the structural adjustments and means that lags of various kinds exist within the
the reformation of government and financial implementation of monetary policy. The central bank
institutions. However, fiscal policies in the past were in itself has both the inside and outside lags to contend
influenced by structural deficits and internal economic with. Inside lags exist because of administrative
volatilities caused by political upheavals in the last delays and delays in the recognition of adverse
two decades. Similarly, the vulnerabilities of large macroeconomic developments in output, employment
monetary shocks bolster the impression that the and prices. While these may be of shorter actual
country’s monetary strategy is less than optimal. While duration than in the case of fiscal policy, the outside
a policy mix feasible enough to achieve the right lag – the length of time it takes before the actual
balance of macroeconomic stability and growth changes in monetary expansion/contraction are felt
remains an elusive dream, it is hoped that the policy on the “target” variables of inflation, output, and
implications arising from the study and relevant to employment – is very significant.
the Philippines would encourage better management
of these major policy instruments. In the monetarist view, expectations adjustment
is a time-consuming process. Comparatively little is
It would be useful, therefore, to undertake an known, however, about the formation of expectations
empirical investigation into the efficiency of both fiscal and other factors affecting the length of lags. For
and monetary policies at achieving the twin macro that reason, a good deal of uncertainty accompanies
objectives under the internal equilibrium of stable the conduct and effectiveness of monetary policy.
growth and low inflation within the framework of the
St. Louis Model. This paper also reviews briefly the Dynamic inconsistency and inflationary bias.
issues around which the fiscal and monetary policies This refers to the difference between the optimal
are hinged, as well as highlights the fiscal and policies that a central bank would announce if it were
monetary policy scenario of the Philippines. considered credible by the public, and the policies it
would carry out after the public had made decisions
Issues on Monetary Policy Efficiency on the basis of its expectations. In reality, however,
the public can discount the announcements of the
Although monetarism is as alive and well as ever, central bank, and the resulting inflation rate will be
considerable skepticism and contrary opinions can higher than it needs to be. As a result, output may or
be found that surprisingly echoes the vital flaw in may not rise above the full employment rate,
human reasoning: expectations. The twin realization depending on current wage rigidities in the system
that it is impossible to observe expectations directly, that prevent complete wage and price adjustments.
and that reasoning is supposed to be based largely on The incentive of policymakers to promote low inflation

Bangko Sentral Review July 2004 33

is constrained by the behavior of rational agents, developments, making sure that long-term policy goals
creating an economy with inflationary bias. are kept in place and there are no short-run
disturbances nor overreactions that will have
Rules versus discretion. The old debate on unfavorable effect on the economy.
rules versus discretion is related to the behavior of
central banks in the conduct of monetary policy: rule- Issues on Fiscal Policy Efficiency
like behavior implies a systematic conduct of policy
without exploiting the existing expectations to achieve The macroeconomic relationship between fiscal
temporary gains in output. Discretion, on the other policy and economic growth has long fascinated
hand, considers the choices of different periods (time- economists. Indeed, fiscal policy has been the major
consistent strategy) and offers mainly a shortsighted policy instrument for macroeconomic management.
solution. As time-consistent policy may bring about However, it has been found to be a clumsy instrument
significant short-run social benefits, economic agents with its attendant delays in the start-up of investment
will learn to anticipate the period-by-period projects, which includes the preparation and floatation
optimization, vitiating the credibility of the policymaker. of tender documents and approval of contracts as
Rules would have provided for more useful well as uncertain impacts due to lags in project
information about the stance of monetary policy during implementation.
particular episodes and a credible central bank is
essential to achieve this. Role of fiscal policy in recession. Recent
years have seen a revival of the debate about the
Sustainability of monetary policy in uncertain role of fiscal policy in stimulating economic activity,
times. In a speech made by William Poole of the particularly given the recessions in Asian crisis
Federal Reserve Bank of St. Louis, he emphasized countries, the prolonged slump in Japan and, more
the inflation objective of the Fed, which is to maintain recently, the slowdown in the United States (Lane, et
a low and stable rate of inflation. The reason for al., 1999). While fiscal policy in the Asian crisis
emphasizing this goal is that the U.S. economy’s long- countries became increasingly oriented toward
run economic performance in terms of employment supporting economic activity, questions still remain
growth and economic growth is maximized when the about the effectiveness of fiscal stimulus during a
rate of inflation is low and stable. Moreover, no other crisis. Even if it is generally agreed that there are
economic policy authority can achieve the inflation circumstances where fiscal policy cannot be loosened
outcome. Hence, controlling the creation of money is (e.g., when fiscal imbalances or debt sustainability
its main responsibility, and exercising that power wisely problems are the root causes of the crisis), whether
is its main monetary policy function. and when expansionary fiscal policy is effective in
supporting activity need to be studied further.
Interestingly, Poole acknowledged the fact that
economic historians studying monetary policy in the Overall, many of the observations appear to be
United States and other countries have argued that broadly in line with theoretical predictions and the
central banks have from time to time made serious following stylized facts emerge (Baldacci, et al.,
mistakes that increased rather than reduced 2001):
fluctuations in the unemployment rate. Certainly, the
first obligation of a central bank is to do no harm. • On average, fiscal policy is expansionary during
Over time, advances in economists’ understanding recession episodes. However, a very large
of macroeconomics and monetary policy have led to number of recession episodes (40 percent of
improvements in monetary policy. total) are accompanied by contractionary fiscal
policy. Unfavorable initial conditions (high
These observations make clear that the issue of public debt, and large fiscal and current account
the length of the lag from the Fed’s policy action is deficits) are associated with a contractionary
not well defined, because the market gradually eases fiscal response in a recession, while negative
its rates in anticipation of eventual Fed action. What terms of trade shocks or a large public sector
central banks can do is to respond sensibly to current tend to result in a more expansionary fiscal
response.

34 July 2004 Bangko Sentral Review

 • There is some evidence that expansionary fiscal The second form of “crowding out” arose from a
policy dampens the severity of a recession, combination of the notion of a supply-side equilibrium
especially in open economies with a fixed (i.e., NAIRU) and that the level of aggregate demand
exchange rate, favorable initial fiscal and would adjust to be consistent with the supply-side
external conditions (low public debt, a large equilibrium. As has been argued above, fiscal policy
public sector, and a small current account has an effect on the level of aggregate demand, and
deficit), and in combination with expansionary “crowding out” only occurs if it assumed that the
monetary policy. Expenditure-led fiscal supply-side equilibrium must be attained and that level
expansions are also associated with less severe of aggregate demand would be equivalent to the
recessions. All these results are consistent with supply-side equilibrium. The third route comes from
the predictions of the theory, even though the the “Ricardian equivalence” proposition. An expansion
magnitude of the average effects is small, and of government expenditure, however funded, is
the variance is large. postulated to lead to an equivalent reduction in private
expenditure, leaving the overall level of demand
• There are marked differences between unchanged (Arestis and Sawyer, 2003).
advanced economies and other country groups.
The fiscal response is more often expansionary Fragile fiscal policy indicators. Unfortunately,
in advanced economies. At the same time, the analyses of fiscal policy indicators have frustrated
impact of fiscal policy tends to be smaller than empiricists for almost as long (Fu, et al., 2003). One
in other groups. root of that frustration is the array of possible policy
indicators. As earlier discussed in Tanzi and Zee
• A number of other factors are associated with (1997), there are three candidate indicators of fiscal
both the fiscal response and the severity of a policy—government expenditures, taxes and deficits.
recession. Inflation tends to be higher, and The literature does not systematically favor one
monetary policy more contractionary during indicator of fiscal policy over the others. Furthermore,
episodes with a contractionary fiscal response, Levine and Renelt (1992) find that none of these fiscal
which makes the interpretation of the results indicators is robustly correlated with economic growth
somewhat difficult and points to the need for a when evaluated individually.
multivariate approach.
The fragility of fiscal indicators found in Levine
Apart from the empirical studies confirming the and Renelt (and contradictory findings in the growth
superiority of fiscal over monetary policy efficiency, literature in general) probably arises from the inability
equally important also is the role of the central bank of any single budgetary component to fully capture
in conducting monetary policy. The latter has attracted the stance of fiscal policy. For example, an increase
arguments as to the ineffectiveness of the policy and in government expenditures could be considered
in assessing the general framework of monetary expansionary if it were financed by deficit spending.
policy, (Barth, 2002) discussed current issues However, it could also be considered contractionary
highlighting the fallacies inherent in the framework: if it were financed by an increase in taxes because
dynamic inconsistencies resulting from rational such a policy would imply an increase in the size of
expectations, and the long standing issue on rules the public sector.
versus discretion.
Keynesian versus Monetarist. The Keynesian
Crowding out effect. There have been three tradition gave government the responsibility of
distinct sets of arguments to the effect that fiscal stabilizing a troubled economy. Keynesians developed
policy will be ineffective, under the general heading the notion of a fiscal/monetary mix to control spending
of “crowding out”. The first, in the context of the IS- and the balance of payments simultaneously. Judicious,
LM analysis, was a “crowding out” due to a rise in well-timed changes in taxes and government spending
interest rates following a fiscal expansion. This was were to be balanced against propitious changes in
based on an exogenous money supply and the interest money to manage the economy. The famous Phillips
rate equating the demand for and supply of money. curve trade-off supposedly gave economists a tool

Bangko Sentral Review July 2004 35

for choosing between inflation and unemployment. If For the sustainability of the fiscal balance, the
the choice did not work out as intended, Keynesians ability of the economy to accumulate savings in order
relied on informal price and wage controls, jawboning to finance its public investment is very important.
(threats), and guideposts to improve the trade-off. Unfortunately, the slow accumulation of savings by
the public sector has been offsetting the high savings
To know when and how much to adjust policies, achieved by the private sector. This resulted in
Keynesian economists developed forecasting models negative savings-investment gap for 17 consecutive
that could simulate possible policy changes to predict years. Further, with the growing trade gap, there has
their effect and more closely adjust the mix of policy been increasing pressure for the private sector to
actions. The Monetarists have always been critical generate private savings and likewise for the
of these models and their use in policy. They favor government to generate a large primary surplus.
stable policy rules that reduce variability and
uncertainty for private decision makers. They argue The second issue relating to fiscal policy for
that government serves the economy best by sustainable growth is the impact of government
enhancing stability and acting predictably, not by trying spending and debt on economic growth. The debt
to engineer carefully timed changes in policy actions. burden keeps the government from providing services
to the people and the necessary infrastructure to help
For the Monetarists, such efforts are frequently improve the economy. The trend in the government’s
destabilizing (that is, doing the opposite of what they budgetary policies is a rising allocation for general
were supposed to do). Thus, the attempt to apply public services and a decreasing budget for economic
Keynesian policies, notably in the United States and services. This means that the government is in essence
Britain produced alternating periods of rising inflation spending more for less important matters and spending
and rising unemployment, and not the finely adjusted less on areas that are more crucial in achieving
trade-off that the Keynesians sought. sustainable growth.

No perfect forecast. Forecasting proved a Fiscal stability after the financial crisis in mid-
weak foundation for policy actions. The best forecasts 1990s remains in jeopardy. To raise its sustainable
of spending, output, prices, and inflation proved to be growth rate, the Philippines needs to close its fiscal
unreliable. Systematic studies of forecasting accuracy gap without necessarily sacrificing essential physical
show that on average forecasters have been unable and social infrastructure, i.e., physical and human
to distinguish between booms and recessions a quarter capital investment. Posting a well-behaved fiscal
or a year ahead, so they are as likely to mislead as to position after the Asian contagion set in, the
benefit policymakers. The records of the Federal government indulged in deficit-spending in an attempt
Reserve that have become available show that during to stimulate the economy out of a mild recession. Both
the period of rising inflation, annual inflation was the revenue (tax collection) and expenditure sides
always under predicted. When inflation fell in the require tremendous restructuring efforts and
eighties, the Federal Reserve persistently predicted commitment.
too high an inflation rate. A vast amount of research
has shown that econometric models cannot accurately Monetary policy. Despite evidence showing that
forecast interest rates and exchange rates. only M1 is co-integrated with interest rates, output
and the exchange rate (Gochoco-Bautista, 1993), the
Philippine Case: Structures and Central Bank of the Philippines (CBP) used M3 or
Arrangements total liquidity as its intermediate target, specifically
because the ultimate target is the rate of inflation.2
Fiscal policy. Fiscal balance is important in As an intermediate target, the CBP used the base
achieving economic stability, and there are two money (BM) as operating target, and the BM is related
important issues that must be addressed: (1) the to M3 via the money multiplier, i.e.
sustainability of the fiscal balance, and (2) the impact
of government spending and debt on the economic M3 = money multiplier x BM
growth (Paderanga, 2001).

36 July 2004 Bangko Sentral Review

 In the mid-1980’s, the CBP conducted monetary inflation targeting would require the use of a wider
policy through monetary aggregate targeting. Under set of information variables on the economy than had
this approach, its policy actions were aimed at been previously utilized. Under inflation targeting,
influencing the behavior of monetary aggregates. monetary authorities in the Philippines would have
Behind this is the presumption that monetary reliable and timely economic indicators and a good
aggregates are meaningful indicators of economic system for economic forecasting, particularly inflation.
activity, implying that there are stable and predictable A well-organized system for economic statistics—
relationships between high-powered money (or the based on reliable, timely and comprehensive
monetary aggregate that the central bank is able to information—enable informed decisions and the
control) and money supply, as well as between money efficient functioning of markets. It is also an essential
on the one hand, and output and inflation on the other element in strengthening the monetary policy decision-
hand. making process by providing a focused and consistent
framework for setting the monetary policy stance
However, financial liberalization in 1993 had led (Tetangco and Tuaño-Amador, 2002).
to changes in financial structures and the evolution
of new financial products and services. These Exchange rate policy. The country’s experience
changes have caused large fluctuations in the money with fixed and then floating exchange rate regimes
multiplier and the velocity of money such that the imparts several important lessons. Recall that the lack
traditional relationships between monetary aggregates of sustainability and implementation of loose financial
(monetary base and money supply) and between policies under the fixed exchange regime resulted in
money supply and the rates of inflation and economic two large devaluations in the mid-1980’s that brought
growth have weakened considerably. Guinigundo about the adoption of a flexible exchange rate in 1985.
(1999) presented evidence supporting this claim: the
money multiplier increased beginning in 1993 after Initially viewed to promote external recovery, it
financial liberalization; however, there was produced mixed results on the inflationary front as
deceleration in the rate of inflation from 9 percent in the economy was left without a nominal anchor for
1994 to 8.1 percent in 1995 despite high rates of domestic prices. The use of base money targets was
liquidity growth in those years. He attributed this uneven, and the exchange rate was not allowed to
inflation performance in part to supply-related factors float freely. Apart from imparting an inflationary bias,
such as the increase in agricultural output in 1994 the implicit shifts between money supply and
and the alleviation of power shortages. exchange rate targets sent conflicting signals to
markets, affecting the credibility of monetary policy
The apparent weakening of these key (Houben, 1997).
relationships under the monetary targeting framework
prompted the Bangko Sentral ng Pilipinas (BSP) to The opening of the economy suggested that an
adopt a “modified targeting framework” beginning exchange rate anchor could be an effective instrument
June of 1995, putting greater emphasis on price to limit inflation. However, a formal exchange rate
stability as well as broadening the information set for commitment would limit monetary policy
monetary policy decisions. This information set independence, making the economy vulnerable once
includes movements in key interest rates, exchange more to large real shocks. It also depends on whether
rate, equity prices, demand-supply indicators and the real exchange rate continues to appreciate
external economic conditions, among other things. (reflecting the rapid structural and technological
improvements).
The BSP’s shift to inflation targeting was
approved by the Monetary Board in 2000 and In such a case, adhering to either a strict
implemented in January 2002. Inflation targeting as monetary or exchange rate anchor could have high
monetary policy framework has emphasized the costs in terms of output growth or inflation. According
central role of information in the conduct of monetary to Houben, the Philippine experience points to the
policy. As a forward-looking and an information- inflation targeting approach as a more viable strategy,
intensive approach to monetary policy, the shift to since monetary policy is targeted directly at inflation,

Bangko Sentral Review July 2004 37

rather than its intermediate targets. By committing to inefficient if one lag is too long and the other too
more stable prices in a more transparent and consistent short.
framework, the monetary authority can maintain some
flexibility to cope with unforeseen shocks. Results of St. Louis model researches. Thus
far, evidence point to the robustness of the St. Louis
The St. Louis Model equation owing both to the specification of its lag
structure and the imposition of polynomial restrictions.
The St. Louis Model is almost an obscure model Taking these into consideration, Batten and Thornton
to begin with. Developed in the early 1970s, it was concluded that in a sample over the period 1962:2 to
described by Andersen and Carlson as a small-scale 1982:3, a one-percentage point increase in money
monetarist model of economic activity (King and growth leads to a one-percentage point increase in
Wolman, 1996). It relates the growth of nominal the rate of growth of nominal GNP cannot be rejected
income (GNP) to changes in monetary and fiscal at conventional levels of statistical significance.
actions that are measured by the growth of money Alternatively, high employment government spending
and government expenditures, respectively. has a permanent impact on the rate of growth of
nominal GNP only when contemporary government
The current version of the St. Louis Model spending growth alone is included in the distributed
consists of five estimated equations and a number of lag of money growth in the model. In the long run,
identities. The centerpiece of the St. Louis Model monetary policy is effective and fiscal policy is
was the total spending equation, put forward by ineffective in influencing the growth of GNP in the
Andersen and Jordan (1968), which put together the U.S. economy.
change in nominal GNP to changes in the nominal
money stock and to (high employment) government Estimation of the St. Louis equation involving six
expenditures. Since the effects of expenditures are developed countries (Canada, France, Germany,
small, the specification embodies the monetarist Japan, the UK and the US) was conducted (Batten
viewpoint that monetary change is the key variable and Hafer, 1983). A modified Andersen-Jordan
that explains nominal income movements while fiscal equation is herein introduced in response to the past
variables only have transitory effect (Meyer and criticism of the original St. Louis equation. Estimating
Varvares, 1981). the modified St. Louis equation for the six countries
yielded results that indicated that changes in money
Limitations. Although its monetarist background growth have a significant and lasting impact on
and structural linkages from money to economic nominal income growth in all six cases. Furthermore,
activity are now widely accepted, the model remains the money-GNP link was stable in all developed
vulnerable to criticisms due to the essential quantitative countries, owing to the then recent move from fixed
effects of expectations (or Lucas’ Critique) in the to floating exchange rates. On the contrary, fiscal
model (Andersen and Carlson, 1970). actions are significant only in the UK and France.

Model specification also posted a problem that While both studies validated the generalized St.
concerns specifying the order of the distributed lags Louis result, there had been attempts at reassessing
(1, K). Batten and Thornton (1984) furthered that in the role of fiscal policy within the framework of the
any finite distributed lag model, a trade-off occurs St. Louis equation (Hafer, 1982). The results are
such that a bias is created in specifying too short a broadly consistent with previous findings. Specifically,
lag (or too low a polynomial degree) against the fiscal actions exert neither a significant nor lasting
inefficiency associated with too long a lag (or too impact on the growth of GNP. The results also provide
high a polynomial degree). Either way, the estimates further evidence against the reliance on fiscal policy
will be unbiased but inefficient. Since the Andersen- measures to explain movements in GNP. It concludes
Jordan equation, and in effect the St. Louis model by saying that fiscal policy measures (1) do not
employs distributed lag equations, it follows that the significantly increase the explanatory power of an
resulting estimates will be biased and may be equation that already incorporates money growth, (2)

38 July 2004 Bangko Sentral Review

do not exhibit stable statistical relationships with GNP The dots above each variable indicate that the
growth, and (3) are not exogenous with respect to equation is estimated in growth rate form. The
GNP growth. modified St. Louis equation is typically estimated with
each distributed lag’s coefficients restricted to lie on
The Andersen-Jordan Equation a fourth-degree polynomial with endpoints constrained
to equal zero.
The centerpiece of the St. Louis Model was the
total spending equation put forward by Andersen and For the Philippines, the following are the data
Jordan (1968), that linked the change in nominal GNP used in the study for the estimation of the St. Louis
to four-quarter distributed lags of changes in the Model: (in growth rates for the period 1986:Q1 to
nominal money stock and of high-employment 2003:Q1, for a total of 69 observations)
government expenditures. Currently specified in rate-
of-change form, it has the following as independent 1. Seasonally adjusted Gross Domestic
variables: nominal income Y, the money supply M Product (GDP) 3 – previous estimations
(M1B is the definition of money currently used with under the St. Louis approach used the GNP
the St. Louis Model), and the high-employment level as the dependent variable. Since we only
of government expenditures G. Dots over the variables measure the domestic implications and
indicate compounded annual rates of change. effectiveness of fiscal and monetary policy,
an internal measure of growth is needed.
The estimates on the M and G variables GDP is used over GNP so as to remove the
approximately sum to unity and zero, respectively. external factors (i.e., net factor income from
Hence, these estimates support the general abroad). To correct the GDP series for
conclusion associated with a monetarist viewpoint: seasonality, the TRAMO-SEATS approach
Monetary change is the key variable explaining was used.4
nominal income movements while fiscal variables 2. Domestic Liquidity (M3) – it reflects a more
only have a transitory effect. relevant feature of total money circulating in
the Philippine economy since it consists of
money supply, peso savings and time deposits
and deposit substitutes of deposit money
However, since monetary and fiscal actions banks held by the general public. Quarterly
obviously affect the foreign sector, discussion on the series of M3 is computed using the average
Andersen-Jordan estimates assume the economy of each 3-month level. The M3 series were
being analyzed is relatively “closed”; that is, its exports sourced from the Bangko Sentral ng Pilipinas
do not account for a large proportion of its GNP. As (BSP).
such, correlation between external and domestic 3. Government Expenditures – it reflects the
influences on GNP is minimized, and external high-level expenditures made by the national
influences excluded in the analysis (Batten and Hafer, government. Quarterly series of government
1983). expenditures were obtained by adding up 3-
month levels of expenditures. The
As a response both to past criticism of the St. Government Expenditure series were
Louis equation and the likely correlation of domestic sourced from the Bureau of Treasury (BTr),
and external influences on GNP, a modified version since they have the sole responsibility of
of the St. Louis model as conceptualized by Batten releasing funds for the consumption of the
and Hafer (1983) is likewise used. national government.
4. Exports – refers to all final goods going out
of the country, which is either classified as
domestic exports or re-exports. The Bureau
where: EX = merchandise exports of Customs (BOC) should properly clear all
Y = GNP export goods. Exports series were sourced
M = narrow money from the National Statistics Office (NSO).
G = government expenditures

Bangko Sentral Review July 2004 39

 Following the Andersen-Jordan equation, the Estimation Results
modified version is formed as:
SAGDPGR = α + β1M3GR + β2GEGR + β3XGR + ε Modified St. Louis model estimation. Under
where: SAGDPGR = seasonally adjusted GDP the 2-years (8-quarter lag) structure, the sum of lags
M3GR = domestic liquidity points to government expenditure having a long run
GEGR = government expenditures
effect on GDP growth, assuming stationarity. Do-
XGR = exports
mestic liquidity and exports do not have a long run
While the original version of the Andersen-Jor- implication on GDP growth. The same result was
dan equation is formed as: obtained under the 3-years (12-quarter lag) struc-
SAGDPGR = α + β1M3GR + β2GEGR + ε ture. Although both domestic liquidity and govern-
ment expenditure are statistically significant, the lat-
From the original and modified versions, the ter possesses a much higher t-statistic.
polynomial distributed lag procedure was employed
with the lags varied from 8 quarters (2 years for the Original St. Louis model estimation. Under
medium to short term) and to 12 quarters (3 years the 2-years (8-quarter lag) structure, the sum of lags
for the long term effect). Thus, it reflected a total of reflects that government expenditure has a long run
four (4) estimation procedures. Statistical analysis impact on GDP growth, assuming stationarity. Under
would be heavily dependent on the sum of lags, since the 3-years (12-quarter lag) structure, government
this has the interpretation of the long run effect of expenditure still possesses a longer lasting effect on
domestic liquidity, government expenditure and GDP growth by virtue of a higher t-statistic than do-
exports, to the seasonally adjusted GDP series. mestic liquidity (see Table 1).

Table 1. Sum of Lags Summary Statistics: St. Louis Model Estimation

2 YEARS LAG STRUCTURE ORIGINAL MODIFIED

Coefficients
- M3 Growth Rate (M3GR) -0.00045 0.02815
- Gov’t Expenditure Growth Rate (GEGR) -0.11946 -0.11078
- Exports Growth Rate (XGR) -0.00131
T-Statistics
- M3 Growth Rate (M3GR) -0.00687 0.43897
- Gov’t Expenditure Growth Rate (GEGR) -1.75210 -1.69588
- Exports Growth Rate (XGR) -0.04508
3 YEARS LAG STRUCTURE ORIGINAL MODIFIED
Coefficients
- M3 Growth Rate (M3GR) -0.12921 -0.14410
- Gov’t Expenditure Growth Rate (GEGR) -0.31279 -0.29423
- Exports Growth Rate (XGR) 0.03927
T-Statistics
- M3 Growth Rate (M3GR) -2.75206* -2.31017*
- Gov’t Expenditure Growth Rate (GEGR) -6.23533* -6.71514*
- Exports Growth Rate (XGR) 1.87009
* Significant at 95%

40 July 2004 Bangko Sentral Review

 Chow breakpoint test results. To bring about G (Granger causes) Y
the significance of any changes from 1994:3 to the 1 year lag structure 3.28916 NO
present - characterized by trade liberalization and the 2 years lag structure 3.38082 NO
Central Bank’s initial steps on implementing the
Y (Granger causes) G
modified monetary targeting framework - testing for
1 year lag structure 3.61739 NO
structural stability was performed. Results show the 1.57069 YES
2 years lag structure
original model of the St. Louis equation proved to be
more stable than the modified version although both X (Granger causes) Y
models failed the stability testing as implied by a low 1 year lag structure 1.20956 YES
F-statistic, thereby higher p-values (see Table 2).
Overall, all the four equations reject the null hypothesis Y (Granger causes) X
of no structural change. Indeed, structural reforms 1 year lag structure 0.53617 YES
and adjustments made by the Philippine government
are deemed vital for sustainable growth in the
domestic economy. Empirical Findings

Table 2. Chow Breakpoint Test (1994:3 Breakpoint) Results from the econometric exercise show that
the policy conclusions of the original and modified St.
EQUATION CALCULATED REJECT
Louis equation are robust with respect to both the
F-STAT STABILITY
specification of its lag structure and the imposition of
ORIGINAL ST LOUIS the polynomial restriction. From the econometric
2 years lag structure 7.75783 NO exercise and the variations applied under the
3 years lag structure 5.974042 NO Andersen-Jordan equation as well as the Almon
MODIFIED ST LOUIS polynomial distributed lag procedure, we find a
2 years lag structure 3.155918 NO counterfactual result, heavily dependent on the sum
3 years lag structure 2.711809 NO of lags: that fiscal policy possesses long-run effects
on real growth rather than the standard monetarist
Granger causality results. Under the viewpoint. Thus, we accept the null hypothesis that
imposition of 4 lags in the Modified St. Louis model, fiscal policy is more effective than monetary policy
government expenditure growth Granger-causes in the long run. Given that the Philippines is only an
GDP growth and vice versa. But under the imposition emerging market and that the basic foundations on
of 8 lags in the Original St. Louis model, only monetary and fiscal frameworks are still being fine-
government expenditure growth Granger-causes tuned, it is likely that real growth is really influenced
GDP growth. Domestic liquidity and exports do not by fiscal actions (budget management, tax collection,
Granger-cause GDP growth and vice versa for both revenue generation and investment projects) rather
lag impositions and for both St. Louis models (see than monetary actions (interest regulation, price
Table 3). stability and financial soundness). The results were
further validated by the outcome of the Chow
Table 3. Granger Causality Test Results Breakpoint and Granger Causality Tests – which
REJECT implies that the structural adjustments made by the
EXOGENEITY TEST CALCULATED EXOGENEITY fiscal sector, and the expenditures made by the
F-STAT OF POLICY national government are indeed vital for sustainable
VARIABLE domestic growth in the Philippines.
M (Granger causes) Y
Reassessing the role of fiscal actions within the
1 year lag structure 1.26116 YES
2 years lag structure 0.72986 YES
framework of the St. Louis equation was further
emphasized. Referring still to the result of updated
Y (Granger causes) M estimates and tests, there is strong evidence validating
1 year lag structure 0.63891 YES the idea that fiscal actions are significant in
2 years lag structure 1.36085 YES determining GDP growth, once the effects of money
growth is taken into account.

Bangko Sentral Review July 2004 41

Concluding Remarks from the St. Louis model show that the fiscal policy
component had driven economic growth from 1986:1
The shift towards an inflation targeting monetary until 2003:1. In this paper, it is argued that shifts in
policy framework had enhanced BSP’s effectiveness the level of aggregate demand cannot be readily offset
in its pursuit of price stability. The transparency by monetary policy. Therefore, fiscal policy remains
mechanism, the use of a wide set of information and a potent tool for offsetting major changes in the level
the forward-looking nature of inflation targeting all of aggregate demand, given floating exchange rates,
contribute to a more effective monetary policy- and some recent developments on inflation targeting
making. With the achievement of a stable price and budget management for the Philippines.
environment, monetary policy plays a key role in
supporting a sustained growth path. However, results

The Authors

Mr. Neil Angelo C. Halcon is Research Analyst II of the Business

Expectations and Leading Indicators Sub-group, Economic and
Financial Monitoring Group of the Department of Economic
Research. He obtained his Master in Applied Economics (M-AE)
degree at the De La Salle University. He also obtained a Bachelor
of Arts degree in Economics with Computer Applications (cum
Halcon De Leon laude) at the San Beda College. Ms. Leah Melissa T. De Leon is
Senior Computer Operator II of the Corporate Planning Services
Group at the Government Service Insurance System (GSIS). She
obtained her Bachelor of Science in Commerce major in
Management of Financial Institutions and Bachelor of Arts in
International Studies major in European Studies (honorable
mention) at the De La Salle University. She recently completed
36 units of academic work towards obtaining a Master in Applied
Economics (M-AE) degree from the same university.

Endnotes
1
This is a condensed version of the research paper submitted by the authors as partial fulfillment of the requirements for
Applied Econometrics at the De La Salle University last August 2003.
2
The use of M3 as intermediate target allows the BSP to prevent excess liquidity, which causes inflation.
3
Taken from data series of Dr. Josef Yap’s article on the output gap.
4
TRAMO, “Time Series Regression with ARIMA Noise, Missing Observations and Outliers”, and SEATS, “Signal
Extraction in ARIMA Time Series”, (Gomez and Maravall, 1996). TRAMO is a program for estimation and forecasting of
regression models with ARIMA errors and missing values. The program interpolates these values, identifies and
corrects for several types of outliers, and estimates special effects such as Trading Day and Easter and, in general,
intervention-variable type effects. SEATS is a program for estimation of unobserved components in time series follow-
ing the so-called ARIMA-model-based (AMB) method; the basic components are the trend-cycle, seasonal, and
irregular components, which are estimated and forecast with signal extraction techniques applied to ARIMA models.
The two programs are structured so as to be used together, both for in-depth analysis of few series or for routine
applications to a large number of them, and can be run in an entirely automatic manner. When used for seasonal
adjustment, TRAMO preadjust the series to be adjusted by SEATS. The two programs are intensively used at present
by data producing and economic agencies, including Eurostat and the European Central Bank.

42 July 2004 Bangko Sentral Review

 REFERENCES

Andersen, Leonall C. and Carlson, Keith M. 1970. A Monetarist Model for Economic Stabilization. Federal
Reserve Bank of St. Louis Review. April 1970.
.
Arestis and Sawyer. 2003. On the Effectiveness of Monetary Policy and Fiscal Policy. Economics Working
Paper No. 369. The Levy Economics Institute.

Baldacci, Cangiano, Mahfouz and Schimmelpfennig. 2001. The Effectiveness of Fiscal Policy in Stimulating
Economic Activity: An Empirical Investigation. November 2001. Preliminary Draft.

Barth, Marvin J. III, Remolona, E. and Wooldridge, P. 2002. Changes in Market Functioning and Central
Bank Policy. Bank of International Settlements.

Batten, D. and Hafer, R. 1983. The Relative Impact of Monetary and Fiscal Actions on Economic Activity:
A Cross-Country Comparison. Federal Reserve Bank of St. Louis Review. January 1983.

Batten, D. and Thornton, D. 1984. “How Robust are the Policy Conclusions of the St. Louis Equation?
Some Further Evidence”. Federal Reserve Bank of St. Louis Review. June/July 1984.

Boivin and Giannoni. 2003. “Has Monetary Policy become More Effective?”. NBER Working Paper No.
9459.

Gochoco-Bautista, M. 2001. “What Drives Monetary Policy?” Discussion Paper No. 0105. University of
the Philippines.

Gochoco, Maria Socorro 1993. “Are Money, Interest Rates, Outputs and the Exchange Rate Cointegrated?
Implications for Monetary Targeting”. The Philippine Review of Economics and Business. Vol.
XXX. No. 1, June 1993.

Guinigundo, Diwa C. 1999. Problems and Issues on Inflation Targeting: The Case of the Philippines. A
paper presented at the conference on “Framework for Monetary Policy in Post-Crisis Asia: Policy
Options and Inflation Targeting”, held on 8-10 December 1999 at Cebu City, Philippines.

Fu, D., Taylor, L. and Yucel, Mine K. 2003. Fiscal Policy and Growth. Working Paper No. 0301. Federal
Reserve Bank of Dallas.

Hafer, R. W. 1982. The Role of Fiscal Policy in the St. Louis Equation. Federal Reserve Bank of St. Louis
Review. January 1982.

Houben, Aerdt C.F.J. 1997. Exchange Rate & Monetary Strategy Options in the Philippines: The Search
for Stability & Sustainability. IMF Paper on Policy Analysis and Assessment. May 1997.

Jayaraman, T. K. 2002. Efficacy of Fiscal and Monetary Policies in the South Pacifc Island Countries:
Some Empirical Evidence. Fiji Islands.

Kimura and Kurozumi. 2002. Effectiveness of History-Dependent Monetary Policy. Bank of Japan.

King, Robert G. and Wolman, Alexander L. 1996. Inflation Targeting in a St. Louis Model of the 21st
Century. Federal Rerserve Bank of St. Louis Review. May/June 1996. Vol. 78. No. 3.

Bangko Sentral Review July 2004 43

Lane, Timothy D., et. al. 1999. IMF-Supported Programs in Indonesia, Korea and Thailand: A Prelimi-
nary Assessment. IMF Occasional Paper No. 178, IMF Washington, DC.

Levine, Rose and Renelt, David. 1992. A Sensitivity Analysis of Cross-Country Regressions. American
Economic Review. Vol. 82.

Meyer and Varvares. 1981. A Comparison of the St. Louis Model and Two Variations: Predictive Perfor-
mance and Policy Implications. Federal Reserve Bank of St. Louis Review. December 1981.

Paderanga, C. 2001. Recent Fiscal Developments in the Philippines. Discussion Paper No. 0110. University
of the Philippines. October 2001.

Poole, William. 2001. Monetary Policy in Uncertain Times. Remarks before the Missouri Bankers Associa-
tion. Senior Bank Management Conference. Mexico. January 2001.

Schaechter, A., Stone, M and Zelmer, M. 2000. Adopting Inflation Targeting: Practical Issues for Emerg-
ing Market Countries. IMF Occasional Paper 202. IMF Washington DC.

Tanzi, Vito and Zee, Hovell H. 1997. Fiscal Policy and Long-run Growth. IMF Staff Papers. Vol. 44.

Tetangco, Amando Jr. and Tuaño-Amador, Ma. Cyd N. 2002. Information Requirements of Inflation Target-
ing in the Philippines. Bangko Sentral Review July 2002. Vol. IV. No. 2.

Yap, Josef. 2003. Output Gap and its Role in Inflation Targeting for the Philippines. Bangko Sentral
Review July 2003. Vol. V. No. 2.

44 July 2004 Bangko Sentral Review