Interest rates, inflation and corruption

Two significant economic events/news in the Philippines happened last week. One was the decrease in the inflation rate in September to 1.9%, and the other was the Banko Sentral ng Pilipinas (BSP) reducing their policy rate to 6% with a probable reduction to 5.75% in December and 5.5% in the first quarter of 2025.

While declining inflation rates does not mean that the prices of goods and services will go down, it means that the price increases will be lower and slower, maybe at an annual rate of 2% to 4% as targeted by the BSP. Prices will not go back to the levels of 2023 or earlier years unless our economy goes into recession or depression; and even if there is a recession/depression it will not go back to the prices in the 1990s or the 1980s. This is actually the weakness of modern economic theory which postulates the need for inflation to keep an economy growing and avoid a recession or depression. The trauma of the 1920s worldwide depression and the more recent COVID-induced recession made governments and monetary authorities even more tolerant of inflation.

Interest rates management is part of Central Banks tools to improve and grow the economy, while keeping inflation tolerable, by making it less expensive for the governments and private businesses to finance/fund investments and operations. The lower BSP rates cascade to the banks and other lenders, that the lower cost of money will encourage the government and private sector to invest/expand projects and businesses. This would increase projects/programs and production, creating more jobs, adding more purchasing power, and consequently increasing the consumption component of the economy. This is the virtuous cycle that modern economics envision which will lead to higher standards of living and well-being of the country’s population.

In the past over 100 years, these have worked in most democratic free market economy countries, and even Russia, China, and other autocratic countries have adopted many free market practices. However, in some countries in Latin America, Africa, and other developing countries, high inflation has blunted/stunted economic development because of political mismanagement and corruption.

The weakness of a market economy has always been governance in government which distorts the workings of a market economy. When governments mandate/prioritize resources to areas/sectors for political reasons and not due to market considerations, the resources are wasted and do not produce the multiplier effects expected. When corruption directs resources to politicians’ private pockets, the resources are not deployed and slow down money velocity. When government projects and programs are overpriced, the cost does not reflect the market price and distorts resource allocation undermining the market pricing.

Singapore would be a good example of a free market economy with a semi-democratic government. Their dominant political party has been in power for a long time, but civil liberties and human rights are respected and honored. Government abuses and corruption are not tolerated, and violators are sanctioned and punished. It is the ideal balanced condition that many countries should aspire even with larger populations and geography.

The Philippines is not in the worst condition as many countries are worse, but we should do better to prevent a worsening situation. Since martial law, we have lost 50 years of economic growth equivalent to 50% of our GDP. Our GDP should have been $700 billion in 2023 and per capita GDP at $7,000/yr. making us a middle-income country.

We should really stop electing unqualified and corrupt politicians as our government officials and leaders. We have another chance to do this in the May 2025 elections.