The two elements of inflation psychology

"Some sleeping dogs should be allowed to lie."



The way that the Duterte administration’s economic managers have been explaining to the Filipino people the short-term prospects for consumer prices, one would think that they don’t know anything about inflation psychology or are pretending that they don’t.

Early in 2018, when the inflationary surge occasioned by the TRAIN (Tax Reform and Inclusion) law was just beginning to make itself felt, the economic managers were predicting that consumer prices would settle down by midyear. When that didn’t happen, they shifted to later-in-the-year; by September the inflation would have simmered down. Now, the economists are talking about reduced consumer price instability by early 2019.

There is absolutely no guarantee that the inflation rate— the recently announced figure for September was 6.7 percent —will slow down significantly anytime soon. Indeed, a continued though slower, upcreep of consumer prices is quite likely.

Why the series of unfulfilled inflation-rate prognostications? As stated above, either the economic managers truly don’t know about inflation psychology or are pretending that they don’t.

Inflation psychology is made up of two elements. The first element is compensation. The other element is anticipation. The second element is arguably the deadlier.

Compensation, or catching up, takes place among three players in the inflation drama: Producers of goods and services, employees—recipients of salaries and wages—and consumers. The inflation drama begins when one of the three players, usually producers of goods and services, choose to or are forced to raise the prices they charge for their goods and services. In order to maintain their purchasing power—and their standards of living—employees then demand shares of the incremental incomes of their employers. And consumers, now having to pay more for the things they consume, likewise proceed to demand salary and wage increases from their own increases.

A catch-up game then ensues, with producers, employers and consumers taking care to ensure that every reduction in their purchasing power—say, through higher food prices or higher transportation or electricity costs—is quickly compensated by upward adjustments in their salaries and wages.

This game of catch-up can last a long time, and it will come to an end —probably a temporary one—only when the players in the inflation drama reach a judgment that those are likely to be no further substantial upward price changes.

Compensatory inflationary movements are fairly easy to track. If they closely and perceptively monitor such movements, they stand a good chance of taming the inflationary surge fairly quickly.

What is far more difficult to deal with is inflation psychology of the anticipatory kind. Producers of goods and services may effect upward adjustments in their price schedules not because of the occurrence of a particular event or price change but in anticipation of a change—political, economic or legal—in the environment in which they operate. Anticipating inflation psychology is highly judgmental in nature and is therefore far more difficult to track and deal with. Oftentimes it is not as easy as arranging a bigger supply of a commodity, e.g., rice; more often than not it arises from a sentiment that bad things are lurking around the corner. “Cover yourself while the covering is good” then becomes a prevalent business strategy.

Some sleeping dogs should be allowed to lie. One of them is inflation psychology. Having been awakened from its slumber by the TRAIN law, inflation psychology is now wide awake and causing much damage to a hitherto stable and growing Philippine economy.

At the rate that the economic managers are dealing with the current inflationary surge, it will probably be a long time before the inflation-psychology dog is made to go back to sleep.

Topics: Tax Reform and Inclusion Law , Rodrigo Duterte , Economy , Inflation
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