It used to be that recessions were accompanied by falling prices. Because of this few people realised that though prices in general fell consumer prices rose relative to producer prices. In other words, capital goods suffered the greatest price declines. Now that central banks inflate to prevent price declines we can find ourselves in a situation where consumer prices are rising faster than producer prices even as a large pool of unemployed emerges. This is stagflation—Gerard Jackson
In this issue:
Stagflation by Design: Policy Contradictions and the
Return of the Pandemic Rescue Playbook
I. Colliding Policies in an Emerging Stagflation
Environment
II. The Triangle of Intervention
III. The Return of War-Time Economics
IV. Energy Bailouts and Socialized Losses
V. BSP’s Hawkish Rhetoric, Shadow Monetary Easing
VI. Ratchet Effect: The Pandemic Rescue Framework That
Never Ended
VII. Oil Shock Meets Banking System Stress Beneath the
Surface
VIII. External Risks: Oil and the Strait of Hormuz
IX. A System Moving Toward Structural Stagflation
X. Conclusion: The Institutionalization of Crisis Policy
Stagflation by Design: Policy Contradictions and the Return of the Pandemic Rescue Playbook
How fiscal dependence on inflation, regulatory interventions, and shadow monetary easing are locking the Philippine economy into a structural stagflation regime.
I. Colliding Policies in an Emerging Stagflation Environment
Recent policy developments across the Philippine economy reveal a system increasingly defined by conflicting interventions.
Authorities have attempted to cushion consumers from rising costs by suspending excise taxes on Liquefied Petroleum Gas (LPG) and Kerosene, while refusing similar relief for gasoline and diesel. The explanation offered by policymakers was not economic but fiscal: the government argued that suspending excise taxes on gasoline and diesel would result in roughly Php 43 billion in lost revenue, compared with about Php 4.1 billion for LPG and kerosene.
This framing reveals the real constraint—fiscal dependence on inflation-driven tax revenues.
At the same time, authorities are pushing in the opposite direction elsewhere in the economy.
The National Food Authority has raised rice buying prices in an attempt to support farmers, while wage pressures are intensifying following minimum wage hikes in Central Luzon and renewed calls for increases in Baguio City.
Authorities are also expanding a new round of credit and income support programs across multiple sectors of the economy. Emergency loan facilities have been announced for micro, small, and medium enterprises (MSMEs), while the Department of Agriculture has introduced loan moratoriums for farmers and fisherfolk facing rising production costs.
The Social Security System has also proposed allocating roughly Php 60 billion for expanded lending programs while accelerating pension increases, alongside discussions of targeted cash assistance for middle-income households and minimum-wage earners.
These measures inject liquidity and sustain household demand while simultaneously raising production costs upstream. The result is a dual pressure dynamic: stronger consumption collides with weakened supply conditions, compressing producer margins, discouraging output, and increasing reliance on imports.
Margin compression weakens domestic supply responses, forcing greater reliance on imports. For a country already structurally dependent on imported food, fuel, and intermediate goods, this dynamic worsens trade deficits and exposes the economy further to external shocks.
Such policy contradictions lie at the core of what economists describe as stagflationary dynamics—a situation where policies designed to alleviate inflation instead weaken production and reinforce price pressures elsewhere.
II. The Triangle of Intervention
Many of the policies now unfolding can be understood through the concept of triangular intervention—a term used by Austrian economist Murray Rothbard to describe government actions that compel or prohibit exchanges between two private parties.
Unlike taxation or subsidies, which transfer resources directly between the state and citizens, triangular interventions reshape the conditions under which individuals and firms are allowed to transact. Price controls, regulatory mandates, credit allocation programs, and production quotas are classic examples because they force market participants to exchange under state-imposed terms—or prevent them from exchanging altogether.
Once such interventions are introduced, additional policies often follow in order to manage the distortions they create.
In practice,
the Philippine policy response increasingly resembles a triangular structure of
intervention linking fiscal transfers, monetary accommodation, and regulatory
relief.
These policy actions are not isolated. They form a
self-reinforcing intervention triangle.
- Price relief
measures reduce immediate political pressure from rising costs.
- Subsidies and
fiscal transfers sustain demand and prevent short-term economic adjustment.
- Inflation-driven tax revenues, particularly through value-added taxes and excise collections, provide the fiscal space to finance those subsidies.
Each corner of the triangle reinforces the others.
A. Price relief
→ reduces political pressure
→ allows inflation to persist elsewhere
B. Subsidies
→ sustain demand
→ delay supply adjustment
C. VAT windfalls
→ finance interventions
→ encourage further policy expansion.
Because value-added taxes are collected as a percentage of nominal prices, inflation automatically boosts government revenue even without legislative tax increases. This dynamic effectively transforms inflation into an implicit tax mechanism that helps finance fiscal deficits
The result is a system characterized by persistent inflation, expanding fiscal intervention, and weakening supply responses—a structure that gradually locks the economy into a stagflationary trajectory.
This dynamic also reflects a broader pattern identified by several strands of economic theory.
Murray Rothbard described how successive government interventions often generate distortions that then justify further intervention in a cumulative process.
János Kornai later characterized similar systems as operating under “soft budget constraints,” where firms and institutions come to expect rescue when financial pressures emerge.
In financial markets, Hyman Minsky observed that prolonged stabilization policies can encourage rising leverage and risk-taking, gradually transforming stability itself into a source of fragility.
The Philippine policy mix increasingly exhibits elements of all three dynamics simultaneously.
III. The Return of War-Time Economics
Many of these policies also resemble the economic management frameworks historically used during wartime mobilization or the "war economy."
Price controls, directed credit programs, industrial coordination, and regulatory mandates were originally designed to manage supply shortages and stabilize critical sectors during periods of national emergency.
In the Philippine case, however, similar instruments are now being deployed outside wartime conditions—reflecting an economy increasingly governed through administrative intervention rather than decentralized market coordination.
IV. Energy Bailouts and Socialized Losses
Recent developments in the power sector illustrate how these dynamics operate in practice.
Regulators recently approved a mechanism allowing Meralco to recover more than Php 4 billion from consumers through tariff adjustments tied to disruptions in gas supply from an affiliate-linked generation facility, effective September.
This episode demonstrates how upstream contractual disruptions are transformed into regulated cost pass-throughs, effectively socializing losses across captive electricity consumers.
Such arrangements stabilize corporate balance sheets while transferring the burden of adjustment to households and businesses.
Additionally, this confirms
our November
2025 analysis of the SMC–MER–AEV deal—an implicit bailout that magnifies
the fragility loop.
V. BSP’s Hawkish Rhetoric, Shadow Monetary Easing
Against this backdrop, the Bangko Sentral ng Pilipinas (BSP) has sought to maintain a public posture of policy discipline, signaling that it has room to raise interest rates.
However, the measures being deployed tell a different story.
Recent announcements include:
- loan grace periods for affected borrowers
- discretion for banks in restructuring distressed loans
- regulatory relief affecting nonperforming loan classification.
While presented as targeted assistance, these policies function as shadow monetary easing. They support bank balance sheets and credit expansion while allowing the central bank to maintain the appearance of a cautious monetary stance.
Crucially, these actions coincide with successive interest rate cuts, aggressive reductions in reserve requirement ratios and the doubling of deposit insurance coverage, both of which expand liquidity within the financial system.
Persistent liquidity expansion also increases pressure on the exchange rate, forcing the central bank to balance domestic financial stabilization against currency defense.
The BSP’s demonstrated preference—judging by its policy actions—points clearly to an easing bias.
Yet, not all bank rescues appear directly in fiscal budgets.
During the 2023 United States banking crisis, for instance, large-scale stabilization measures were implemented primarily through central bank liquidity facilities rather than explicit fiscal bailouts.
The Philippine approach appears to be moving along a similar path.
VI. Ratchet Effect: The Pandemic Rescue Framework That Never Ended
Authorities deployed this stabilization framework during the pandemic recession as an emergency response.
More than five years later, however, that emergency
architecture has not been unwound. Instead of normalization, deficit spending
has become structurally embedded in the system.
Figure 1
Public
debt continues to reach new highs. Universal
and commercial bank lending relative to GDP is at record levels, while
public debt-to-GDP has climbed back to levels last seen in 2005. (Figure 1, upper and lower graphs)
Figure 2
At the same time, both banking system net claims on the national/central government (NCoCG) and central bank exposures have expanded significantly, drifting near or exceeding historical peaks. (Figure 2, upper window)
Fiscal outcomes reinforce this pattern. The 2025 deficit ranks among the largest in the country’s history, while combined public and formal financial sector leverage has risen to approximately 113 percent of GDP.
Liquidity conditions tell the same story. Although M2 broad money has declined from its pandemic peak of roughly 76 percent of GDP in 2021, it remained near 70 percent in 2025—well above historical norms. (Figure 2, lower diagram)
All told, these trends suggest that pandemic-era interventions did not merely stabilize the economy temporarily; they fundamentally reshaped its structure.
The system now operates with a deepening reliance on elevated leverage, abundant liquidity, and recurring policy support.
This dynamic closely reflects the Robert Higgs concept of the "ratchet effect," where government expansion during crises is rarely reversed. Instead, emergency measures leave behind institutional and political legacies that permanently raise the baseline of state intervention, making each subsequent intervention easier to justify and more difficult to unwind.
VII. Oil Shock Meets Banking System Stress Beneath the Surface
Pre-Iran war banking data indicates that pressures may
already be building beneath the surface.
Figure 3
The ratio of cash to deposits fell in February 2026 to its lowest level in at least a decade. (Figure 3, upper pane)
Meanwhile, liquid assets relative to deposits, although rebounding slightly in February, remain near levels last seen during the early months of the pandemic in 2020.
At the same time, banks have been rapidly increasing their holdings of available-for-sale (AFS) securities, which surged over the past three months to one of the highest nominal levels on record. This expansion may be temporarily boosting reported liquidity metrics. (Figure 3, lower image)
Credit quality indicators show similar dynamics.
Figure 4
Allowances for credit losses have reached record levels, reflecting suppressed loan provisions as total loan portfolios continued expanding. Gross nonperforming loans also jumped in February to a new high. (Figure 4, upper and lower charts)
For much of the past year, rapid credit growth masked a deterioration in loan quality. The recent surge suggests that this buffer may now be fading—which may help explain the latest regulatory relief measures affecting NPL classification.
Figure 5
Interbank lending has also reached record levels, while repos with other banks remain near historic highs. (Figure 5, upper visual)
Meanwhile, banks increasingly rely on bond and bill borrowings as funding sources rather than traditional deposit growth. (Figure 5, lower image)
Conjointly, these trends resemble a classic “Wile E. Coyote” dynamic from the denominator effect—where balance sheet stresses remain temporarily suspended by rapid credit expansion until underlying conditions eventually reassert themselves.
An oil
shock may ultimately expose the fragilities embedded in this dynamic.
VIII. External Risks: Oil and the Strait of Hormuz
These domestic vulnerabilities are unfolding at a time when external risks are rising.
Despite earlier statements about reopening the Strait of Hormuz, Iranian officials appear to have reversed course and announced its continued suspension, raising the risk of disruptions to global shipping along one of the world’s most critical oil transit routes.
For energy-importing economies such as the Philippines, any disruption in Gulf oil flows would amplify domestic inflation pressures and widen trade deficits—further complicating monetary policy decisions.
IX. A System Moving Toward Structural Stagflation
All told, these developments reveal an economy increasingly shaped by persistent and deepening intervention, expanding leverage, and fragile financial balances.
Fiscal authorities attempt to suppress consumer price pressures while raising upstream costs. The central bank maintains hawkish rhetoric while quietly deploying liquidity support measures. Banks rely increasingly on credit expansion and market funding to sustain balance sheets.
The policy framework introduced during the pandemic—once described as temporary emergency stabilization—now appears to have become the operating regime.
Current developments are unfolding broadly in line with the expectations we articulated in June 2025 regarding the government’s response to rising economic pressures.
Without a doubt, the BSP will likely rescue the banks and the government, perhaps using the pandemic template of forcing down rates, implementing reserve requirement ratio (RRR) cuts, massive injections (directly and through bank credit expansion), and expanding relief measures—though likely with limits this time.
If the central bank ultimately resorts to a full revival of its pandemic rescue playbook—aggressive rate cuts, further reserve requirement reductions, and large-scale liquidity injections—the consequences are unlikely to resemble the temporary stabilization achieved in 2020.
Instead, the outcome could be a familiar combination:
- a weakening currency or the Philippine peso,
- renewed inflation pressures,
- rising risk of unemployment,
- slowing economic growth, and
- rising interest rates.
In other words, the economy may be drifting toward the
very outcome policymakers are attempting to avoid—a structurally entrenched stagflationary cycle.
X. Conclusion: The Institutionalization of Crisis Policy
What is emerging in the Philippines is not merely a temporary economic slowdown triggered by external shocks. Instead, it reflects the gradual institutionalization of a policy framework built around continuous crisis management.
Emergency transfers, directed credit programs, regulatory relief, and fiscal expansion have become the populist default responses to economic stress. While each intervention may appear justified in isolation, their cumulative effect is to embed an economic system increasingly dependent on state support.
Over time, such policies weaken market discipline, distort investment decisions, and transfer growing economic risks onto public balance sheets.
As economists Hyman Minsky and János Kornai observed in different contexts, systems sustained by repeated stabilization measures often appear stable until underlying imbalances become too large to contain.
The danger is not simply that stagnation and inflation coexist.
The deeper risk is that a policy
regime designed to manage crises may itself become the mechanism through which crisis
dynamics intensify.
