What people
today call inflation is not inflation, i.e., the increase in the quantity of
money and money substitutes, but the general rise in commodity prices and wage
rates which is the inevitable consequence of inflation. This semantic
innovation is by no means harmless—Ludwig von Mises
Stagflation, Part 12: The Philippines' Balance-Sheet
Origins of Inflation
I. Preamble: Interconnectedness of All Economic
Phenomena
II. Following the Money: The Balance-Sheet Origins of
Inflation
IIA. Why This Matters: From External
Discipline to Domestic Bailout
IIB. Following the Credit: Electricity and the
New Transmission of Liquidity
IIC. When Balance Sheets Become Policy: From
Liquidity to Prices
III. Oil Relief, Monetary Inflation, and the Return of
Deferred Prices
IIIA. Administrative Suppression Is Not Price
Stability
IIIB. The Poor Continue Paying the Highest
Inflation Tax
IIIC. Benchmarkism and the Illusion of Labor
Absorption
IIID. Wage Mandates and the Intervention
Spiral
IV. Conclusion: Inflation Before Prices
Stagflation, Part 12: The Philippines' Balance-Sheet
Origins of Inflation
Why Consumer Prices Reveal the Consequences, Not the
Beginning, of the Process
I. Preamble: Interconnectedness of All Economic
Phenomena
Economic commentary often treats macroeconomic releases
as though they describe separate realities. Bank lending is analyzed
independently of inflation. Labor market statistics are discussed apart from
monetary policy. Wage adjustments are framed as social policy, while
electricity is relegated to industry news. Each release receives its own
headline, its own narrative, and then quickly disappears into the next news
cycle.
Yet the economy functions as an interconnected process
rather than a collection of isolated indicators.
As Ludwig von Mises observed,
economics "does not allow of any
breaking up into special branches." It is concerned with "the interconnectedness of all phenomena of
acting and economizing." Economic facts condition one another, and
each problem can only be properly understood within a broader system that
assigns its due place to every aspect of human action and economic choice.
Money created through the banking system finances
specific borrowers. Credit helps determine which investment projects become
financially viable, influencing the allocation of resources, production costs,
employment, asset prices, and eventually consumer prices. Monetary developments
therefore propagate through the economy sequentially rather than
simultaneously.
The political environment further shapes this process by
influencing the prevailing model of economic development. Governments
frequently respond to the unintended consequences of earlier interventions with
additional interventions. Each successive policy alters incentives, redirects
capital toward politically favored sectors, and generates new distortions that
invite further intervention, progressively reducing the economy's capacity to
adjust through market processes.
These developments are not isolated events. They
represent successive stages of the same underlying process.
The Philippine economy today provides an instructive
example.
Conventional narratives frame these developments as
isolated economic events. In reality, they form an interconnected process that
reflects the deepening consequences of balance-sheet expansion, politically
driven credit allocation, and successive policy interventions.
The sequence matters because inflation does not begin at
supermarket shelves, gasoline stations, or electricity bills. Nor does it begin
with the consumer price index. By the time consumer prices visibly accelerate,
the underlying monetary and financial adjustments have often been unfolding for
a period. Markets respond to underlying conditions. What is seen as inflation is, therefore, a symptom.
The process begins elsewhere.
It begins with the expansion of balance sheets.
II. Following the Money: The Balance-Sheet Origins of
Inflation
One of the recurring shortcomings of contemporary
macroeconomic analysis is its tendency to treat inflation primarily as a phenomenon
of price changes.
Policymakers, talking heads, and financial markets
closely monitor consumer price indices because they are readily observable,
politically salient, and easily communicated. Rising food prices, higher
electricity bills, and more expensive transportation become the visible
face of inflation.
Because consumer prices are both politically sensitive
and immediately observable, inflation is also commonly framed as a problem
originating in markets rather than in monetary or policy decisions. The mechanical focus is on the supply side.
Thus, the resulting narrative emphasizes shortages, speculation, supply-chain
disruptions, hoarding or price gouging, encouraging corrective political interventions,
while the monetary and administrative
policies that altered purchasing power and resource allocation receive
comparatively little or no scrutiny at all.
Yet the price changes captured by official statistics
describe only one observable manifestation of a much broader monetary and
financial process.
Consumer price
indices summarize exchange ratios over a given period; they do not reveal how
the purchasing power underlying those transactions was created, allocated, and
transmitted throughout the economy.
Before consumer price indices register sustained
inflation, balance sheets have often been expanding for months. Before
households pay more at the grocery, someone must first acquire additional
purchasing power. Before firms bid more aggressively for labor, raw materials,
or imported inputs, someone must first obtain financing that enables such
spending.
Within the
financial system, the interaction of savings, credit creation, monetary policy,
and bank intermediation determines how purchasing power is created, allocated,
and transmitted throughout the economy.
These financial adjustments reshape resource allocation,
investment decisions, production structures, and distribution, eventually
influencing employment, incomes, spending patterns, and consumer prices.
Periods of monetary accommodation magnify the imbalances
(excess leverage, credit concentration, politically directed finance, sectoral
distortions) that developed in the process.
Monetary conditions have evolved through successive
phases rather than discrete episodes. The BSP's earlier pandemic-era
monetary expansion was followed by a period of policy tightening to contain
rising inflation. Beginning in the second half of 2024, however, the BSP
gradually shifted toward monetary accommodation through successive reductions
in policy rates and reserve requirements. Rather than immediately accelerating
consumer prices, these measures first affected the financial system by lowering
funding costs, intensifying the expansion of banks' capacity to extend credit,
increasing system-wide liquidity, and encouraging further balance-sheet
expansion.
These changes in monetary and credit conditions
propagated or diffused gradually through the economy. As new purchasing power
entered through bank lending and other financial channels, it influenced
financing decisions, resource allocation, investment activity, and "aggregate
demand" before becoming fully reflected in consumer price measures.
The BSP's May
2026 Depository Corporations Survey (DCS) illustrates this transmission
process.
Broad money continued to accelerate for a fourth
consecutive month.
Figure 1
M3 expanded by 12.8 % year-on-year, following growth of
10.3 % in February, 12.1 %in March, and 12.2 %in April. (Figure 1, topmost
pane)
While the various monetary aggregates have not followed
identical trajectories over recent years, the May data point to increasingly
broad-based liquidity conditions.
- Cash in circulation, which had recently trailed the other
aggregates in growth, rebounded.
- M1’s growth trend remained robust, sustaining the
momentum from its earlier expansion in 2023.
- M2 and M3 growth accelerated in Q2 2025, showing that
monetary expansion had become more widely distributed across the financial
system rather than concentrated in a single aggregate.
The significance of these figures lies not merely in
their magnitude but in what they reveal about the sources of liquidity.
The current
acceleration in liquidity growth echoes the BSP’s pandemic‑era response.
And while the DCS shows that domestic credit remained the principal driver of
monetary expansion, the transmission channel has shifted.
Banks net claims on central government (NCoCG) rose 16.2%
to Php 6.4 trillion. (Figure 1, middle image)
Claims on the public non‑financial sector accelerated
even more rapidly, surging 41.2%, coinciding with the DOF’s
proposed record remittances of GOCCs to the national government. Are banks
financing the GOCC remittances?
Lending to the private sector also strengthened to 13.2%,
though at a more moderate pace.
The banks’ net claims share of domestic claims stood at 27.1%
in May 2026, slightly down from the record 27.6% in May 2024, while claims on
the private sector reached 64.23%, sharply lower despite recovering from its
interim trough in Q4 2023. Since the pre‑pandemic year 2019, bank net claims on
the central government have taken an increasingly larger share of domestic
claims—a clear sign that liquidity creation now stems primarily from bank
financing of the government. (Figure 1, lowest diagram)
Figure 2
In the meantime, BSP’s
net claim on central government (NCoCG) growth doubled in May to Php 662.6
billion, though it remains below pandemic levels. (Figure 2, topmost window)
In sum, these developments suggest that the recent
acceleration in monetary growth has been driven primarily by continued domestic
balance-sheet expansion by banks and the government-BSP complex rather than by
external sources of liquidity.
Although the current expansion differs from the pandemic
response in both scale and transmission mechanism, its underlying balance-sheet
logic is strikingly similar. Liquidity
is once again being created through coordinated expansion of public and
banking-sector balance sheets—not primarily to finance new productive
activity, but to sustain an increasingly leveraged economic structure.
Unlike 2020, the current process operates largely through
the routine mechanisms of government finance, central-bank operations, and bank
credit rather than emergency facilities.
Nevertheless, the recurring liquidity injections exhibit
the characteristics of a
quasi-bailout whose monetary consequences gradually diffuse through the
economy before becoming visible in consumer prices.
IIA. Why This Matters: From External
Discipline to Domestic Bailout
For many years, discussions of Philippine liquidity
focused primarily on external sources of monetary expansion—remittances, export
earnings, business process outsourcing receipts, tourism revenues, foreign
portfolio flows, foreign direct investment, and movements in the country's
international reserves.
These external inflows undoubtedly influence domestic
liquidity conditions. Historically, the accumulation of foreign exchange
reserves also imposed an important discipline on domestic monetary expansion,
as the BSP's
balance sheet remained closely linked to developments in the external
sector.
Over time, however, the growing financing requirements of
the domestic economy increasingly shifted the source of monetary accommodation
inward.
Ever since the 1997 Asian crisis, the BSP built up
foreign reserves, which held nearly fixed at ~86–87% of assets from 2012 to
2018, culminating in 2019. Pandemic injections of $2.3 trillion cut that share
to ~72%, as historic liquidity infusions raised domestic securities to nearly
20% — exposing peso fragility. (Figure 2, middle graph)
While BSP has since reduced its domestic securities share
and rebuilt reserves, banks now carry the burden of financing sovereign
liabilities.
As an aside, strangely, the BSP has yet to publish
its monthly updates for 2026
Consequently, this reinforced the larger role of domestic
credit creation in expanding liquidity — a greater reliance on internally
generated purchasing power rather than external inflows.
Equally revealing are developments on the liability side
of the banking system.
Deposit
substitutes—including money-market borrowings, promissory notes, and
commercial paper—accelerated sharply. After expanding by just over 10 % year-on-year
in February, their growth surged to
nearly 74 % in April before approaching 95 % in May. Wholesale funding has
therefore become an increasingly important source of financing for continued
balance-sheet expansion. (Figure 2, lowest chart)
The changing
composition of bank liabilities provides important clues about conditions
within the financial system. Rather than merely reflecting a preference for
alternative funding structures, the growing reliance on wholesale liabilities
suggests that banks theoretically are adapting to funding, regulatory, and
balance-sheet constraints while sustaining asset growth. It also reflects the increasingly
important role of market-based financing in supporting credit creation when
traditional deposit growth alone becomes insufficient.
That evolution carries important implications.
Conventional narratives often portray banks as simple
intermediaries that collect household savings before lending those funds to
borrowers. Modern banking systems operate differently. Through credit
expansion, bank lending simultaneously creates deposits, expanding both assets
and liabilities on bank balance sheets.
The composition of those balance sheets, however, is
equally important. As a growing share of bank assets becomes concentrated in
public-sector claims and other policy-influenced lending, while portions of
private-sector credit remain constrained by weaker credit quality and elevated
non-performing loans, the organic growth of deposits becomes less sufficient to
sustain continued balance-sheet expansion. The
sharp increase in wholesale liabilities therefore appears less a voluntary
shift in funding strategy than an institutional response to mounting
balance-sheet pressures, with banks increasingly relying on market-based
funding to support continued liquidity creation.
Understanding this mechanism fundamentally changes how
monetary statistics should be interpreted.
Liquidity is not merely a passive consequence of economic
activity. It is created through identifiable balance-sheet transactions that
determine who first receives newly created purchasing power, under what
conditions, and for what purposes.
This is where aggregate monetary statistics become
insufficient.
Headline M3 describes the resulting expansion of
liquidity. It does not reveal how that liquidity was created, through
whose balance sheet it entered the economy, or which borrowers received the
newly created purchasing power.
Money does not
enter the economy uniformly. New purchasing power enters through
specific borrowers, particular industries, and identifiable financial channels
before gradually spreading throughout the broader economy. Those early
recipients acquire the ability to bid for labor, raw materials, imported
inputs, financial assets, and productive resources before the nominal incomes
of later recipients adjust. Relative prices therefore begin changing well
before those adjustments become visible in aggregate price indices.
Price changes
themselves reflect the interaction of supply and demand. Without
additional money or credit to finance higher spending, stronger
demand in one part of the economy generally requires weaker demand elsewhere.
Generalized inflation therefore requires
an expansion of purchasing power beyond the mere redistribution of existing income
and savings. Even supply shocks initially alter relative prices; they
become broader and more persistent only when accommodated by monetary expansion.
As the late Nobel Laureate economist Milton Friedman reminded us:
inflation is always and everywhere a
monetary phenomenon — produced only by a more rapid increase in the quantity of
money than in output.
This is why some industries expand more rapidly than
others. Certain asset prices appreciate long before consumer prices accelerate.
Input costs often rise months before those increases appear in finished goods.
The process is neither instantaneous nor evenly distributed. It unfolds
according to the channels through which money and credit enter the economy.
The balance sheet therefore provides the first map of
inflation's transmission.
If the Depository Corporations Survey explains how
liquidity is created, the BSP's lending statistics reveal where that newly
created purchasing power is increasingly being directed.
That question is particularly revealing in the current
Philippine context.
Aggregate lending growth accelerated during May. Yet the
headline figure conceals a more important structural development. The
composition of credit—not merely its quantity—provides the more meaningful
signal.
Among all sectors of the economy, one has emerged as the
largest destination for new bank financing.
The electricity sector.
IIB. Following the Credit: Electricity and the New
Transmission of Liquidity
If the Depository Corporations Survey (DCS) reveals the
expansion of monetary and banking-system balance sheets, the BSP's Universal
and Commercial (U/C) Bank Lending data reveals how newly created purchasing
power is allocated across sectors of the economy. Together, the two datasets provide
complementary views of the same process: one identifies the expansion of
liquidity within the financial system, while the other shows where credit
creation is concentrated.
The May lending report continued to show a rapid pace of
credit expansion. Total outstanding loans of universal and commercial banks
accelerated from 11.84 %year-on-year growth in April to 12.62 %in May,
extending the recovery in bank lending that followed the BSP's shift toward
monetary easing.
On the surface, these figures suggested improving
financial conditions and stronger economic activity.
Aggregate lending growth, however, reveals only the
quantity of credit creation. The more important question is where that credit
is being allocated.
Figure 3
Consumer lending, which had been one of the principal
drivers of post-pandemic credit expansion, continued to decelerate gradually
while remaining elevated. Consumer loans slowed from 19.58 %to 19.03 percent,
while credit-card lending eased slightly from 26.57 %to 26.30 percent. (Figure
3, topmost visual)
Household borrowing therefore remained strong, but it was
no longer the dominant source of credit expansion.
Production lending moved in the opposite direction.
Loans to production activities accelerated from 10.70 %to
11.67 percent, suggesting that banks were directing a larger share of new
lending toward business-related activities rather than household consumption.
Under normal conditions, such a shift would generally be interpreted as
favorable, as productive investment should expand capacity, increase output,
and support long-term economic growth.
The sectoral composition of production lending, however,
reveals a more complex picture.
Among major industries, electricity, gas, steam, and air-conditioning supply recorded the
strongest expansion by a wide margin. Outstanding loans to the sector increased
by 31.65 % year-on-year, accelerating from 25.83 %in April. (Figure 3, middle
image)
More significantly, electricity accounted for the largest
absolute increase in bank lending among all industries, adding approximately Php133.3
billion in a single month and roughly Php539.2 billion over the preceding
twelve months.
As a result, the sector's share of total universal and
commercial bank loans increased from 12.2 %in May 2025 to 14.5 %by May 2026,
reaching its highest level since the BSP began publishing the current series!
This is not simply another industry experiencing rapid
credit growth.
It represents a significant reallocation of the banking
system's balance sheet.
Balance sheets often reveal structural changes before
those changes become visible in national income statistics. Financing patterns,
investment decisions, and credit allocation frequently adjust before their
consequences appear in GDP, employment, or consumer-price data. Following the
money therefore requires examining not only how much credit is created, but
also which sectors receive that credit.
This pattern also reflects broader developments within
the Philippine electricity sector.
Our previous analysis examined how mounting financial
pressures within the industry were increasingly addressed through institutional
restructuring, financing arrangements, and regulatory adjustments rather than
through explicit fiscal appropriations. A series of developments pointed in the
same direction: the SMC–Aboitiz
Equity Ventures–Meralco (Chromite) Batangas LNG deal, Prime
Infrastructure's acquisition of First Gen, the
suspension of real-property taxes (RPTs) on power assets, and the introduction
of the Government Energy Auction Allowance (GEA-ALL) on top of the existing
FIT-ALL mechanism. Although different in form, these measures reflected a
broader effort to maintain the financial viability of a strategically important
sector while limiting reliance on direct fiscal support.
The important observation is that the banking system has become an increasingly important channel
through which financing reaches the electricity sector. Given that
electricity-sector output has remained weak despite rapid credit expansion, the
increase in lending raises questions beyond simple investment financing. Electricity GDP
has stagnated since Q2 2025 (Figure 3, lowest graph)
This reflects a quasi‑bailout scheme channeled through
refinancing requirements, balance‑sheet restructuring, and regulatory
incentives.
Government‑affiliated private sector balance sheets
absorb pressures that would otherwise appear on public accounts. Rather than
showing up as fiscal expenditure, burdens are transferred via corporate
restructuring and commercial banks, facilitated by regulatory adjustments. The
cost does not disappear; it migrates across balance sheets, masking fragility
under the guise of restraint.
In this environment, the boundary between monetary
policy, industrial policy, and financial-sector policy becomes increasingly
difficult to separate.
Credit allocation does not require formal central
planning to influence economic outcomes. Once liquidity expands within the
banking system, institutions respond to incentives, regulations, collateral
conditions, risk assessments, and political priorities. The resulting
allocation of credit reflects not only private lending decisions but also the
broader institutional environment in which those decisions occur.
This is why following the money requires following the
balance sheet rather than the budget alone.
The modern transmission of policy increasingly operates
through credit markets.
IIC. When Balance Sheets Become Policy: From Liquidity to
Prices
The
significance of electricity lending extends beyond a single industry. It
illustrates a broader feature of modern monetary transmission: the effects of
monetary accommodation depend not only on the quantity of liquidity created,
but also on where newly created
purchasing power is allocated.
The May DCS and
lending reports reveal two dimensions of the same process. The DCS shows the
continued expansion of liquidity through domestic credit creation, while
lending data reveal how that purchasing power is distributed across sectors.
Credit directed toward different uses—financial assets, real estate,
consumption, infrastructure, utilities, or government financing—produces
different effects on investment decisions, resource allocation, and relative
prices.
The
transmission from monetary expansion to consumer prices is therefore neither
immediate nor uniform. Newly created purchasing power enters the economy
through specific financial channels, affecting particular borrowers and sectors
before broader price effects emerge.
The May
balance-sheet and lending data indicate that these earlier stages of the
process remain active. Liquidity continues expanding, domestic credit remains
the principal source of monetary growth, and bank lending increasingly reflects
sectoral concentrations, including electricity.
June's
inflation report should therefore not be interpreted as an isolated movement in
consumer prices. It represents a later stage of a monetary and credit process
already visible within the financial system.
The balance
sheet reveals where the process begins. Consumer prices reveal where it
eventually appears.
The significance of electricity lending extends beyond a
single industry. It illustrates a broader feature of modern monetary
transmission: the effects of monetary accommodation depend not only on the
quantity of liquidity created, but also on where newly created purchasing power
is allocated.
III. Oil Relief, Monetary Inflation, and the Return of
Deferred Prices
Having followed the creation of liquidity through the
banking system and traced its allocation across the economy's balance sheets,
the analysis now moves to where these monetary processes become most visible:
consumer prices.
June's inflation report was widely interpreted as
evidence that inflationary pressures were easing. Headline consumer
price inflation declined from 6.8 %in May to 6.4 percent in June,
reinforcing the view that price pressures were gradually moderating and that
recent policy measures were beginning to stabilize conditions.
The underlying picture, however, was more complex.
Figure 4
The decline in headline inflation was driven primarily by
a factor external to domestic monetary conditions: the sharp reduction in
global oil prices. West Texas Intermediate crude declined by more than 23 % during
June, easing one of the most significant cost pressures affecting households
and businesses. (Figure 4, topmost window)
Transport inflation correspondingly slowed from 16.2 %to
12.8 percent, contributing substantially to the moderation in the overall
index. (Figure 4, middle image)
Had inflation been primarily a fuel-price phenomenon, the
decline in headline inflation would have represented a broader improvement.
The underlying data suggest otherwise.
Core inflation accelerated from 4.1% to 4.4%, indicating
that price pressures were becoming more broadly distributed beyond volatile
food and energy components. The breadth of monthly price movements also
remained significant: only three of the
thirteen major CPI divisions recorded declines, while eight increased and two
remained unchanged.
The decline in headline inflation therefore reflected the offsetting effect of a major temporary
component rather than a broad reversal of inflationary pressures. Lower oil
prices reduced one important source of cost pressure, but they did not
eliminate the monetary and credit conditions that had already influenced other
parts of the economy.
As established in Part I, monetary expansion does not
affect all prices simultaneously. Newly created purchasing power enters through
specific financial channels, influencing particular borrowers, industries, and
production decisions before broader consumer-price effects emerge.
June's CPI data should therefore not be interpreted as
contradicting the monetary process. They illustrate its continuing
transmission.
The BSP's monetary data reinforce this interpretation.
Broad money expanded by 12.8% in May, marking the fourth consecutive month of
double-digit M3 growth. (Figure 4, lowest chart)
Such expansion does not mechanically determine a precise
monthly inflation outcome; monetary transmission operates through time and
through changing economic structures. However, sustained liquidity growth
provides the financial conditions through which localized price pressures can
become more broadly embedded.
This distinction is essential because supply conditions
and monetary conditions operate differently.
Supply disruptions can alter relative prices. Higher oil
prices increase transportation costs. Poor harvests reduce agricultural supply.
Geopolitical conflicts and supply-chain disruptions affect specific markets.
But relative-price changes alone do not create sustained
economy-wide inflation. Without additional purchasing power, higher spending in
one category must generally reduce spending elsewhere. A rise in one set of
prices is offset by weaker demand in another.
Generalized
inflation requires a mechanism that allows nominal spending to expand across
multiple sectors simultaneously.
That mechanism is provided by monetary and credit
expansion.
The balance sheets examined in Part II explain how that
purchasing power entered the economy.
The CPI data reveal where those monetary effects are
becoming visible.
IIIA. Administrative Suppression Is Not Price Stability
June's inflation data also illustrate a recurring feature
of price management: suppressing visible
price increases does not necessarily resolve the conditions producing them.
When politically sensitive prices rise, policymakers
often respond by attempting to manage the observed price outcome directly
through administrative measures, subsidies, regulatory interventions, or
temporary restrictions. Such measures may provide short-term relief, but they
do not eliminate the underlying economic pressures affecting supply, costs, and
incentives.
Rice provides one example.
Figure 5
Despite the continued implementation of the Maximum
Suggested Retail Price (MSRP), import liberalization measures, 20 pesos rice
rollouts and further policy interventions affecting rice markets, rice inflation remained elevated at close
to 15 %in June, only marginally lower than May's 15.6 percent. (Figure 5, upper
diagram)
The persistence of high rice inflation demonstrates the
limits of administrative measures as a substitute for resolving underlying
supply and cost pressures. A controlled price may temporarily alter the
reported price path, but it cannot by itself change the economic conditions determining
production, distribution, and availability.
The irony is, despite this, authorities
still propose to extend price caps!
Electricity provides another important illustration.
During June, Wholesale
Electricity Spot Market (WESM) prices increased by approximately 23
percent, with particularly sharp movements in the Visayas. The development
attracted limited public attention despite its potential implications for
future consumer prices.
Earlier in the year, authorities temporarily
suspended aspects of WESM pricing under Executive
Order No. 110 before subsequently restoring market-based pricing
mechanisms. The objective was understandable: electricity prices had become
politically sensitive, and temporary intervention offered immediate relief.
However, prices
perform a crucial and indispensable economic function. They transmit
information about scarcity, and costs necessary for economic calculation.
Administrative intervention can delay that information from appearing in
observed prices, but it cannot eliminate the underlying pressures that
generated it.
When market pricing resumes, adjustments may reflect not
only current conditions but also costs that accumulated during the period of
suppression. What appears to be a sudden
price increase may therefore represent deferred price discovery rather than a
newly emerging problem.
The same principle applies beyond electricity. Temporary
relief measures introduced during the earlier oil-price shock have since been
reversed, restoring
excise-tax collections while households continue facing elevated living costs.
The sequence demonstrates a recurring
policy tension: measures that to supposedly protect consumer gives way to other
political priorities.
Administrative intervention can influence the timing of
price adjustments.
It cannot permanently remove the economic forces
requiring those adjustments.
When underlying pressures are postponed rather than
resolved, inflation does not disappear. Its transmission is merely delayed,
redistributed, or redirected through other channels.
IIIB. The Poor Continue Paying the Highest Inflation Tax
Headline inflation also conceals an important
distributional reality.
Aggregate price indices describe an average household. No
household is actually average.
The BSP and the Philippine Statistics Authority recognize
this distinction by publishing separate inflation measures for the
Bottom 30 %of income households. These statistics often provide a clearer
picture of inflation's social consequences because lower-income households
devote a larger share of their budgets to essential goods.
June's data offered little relief.
Although the gap between Bottom-30 food inflation and
headline food inflation narrowed slightly—from 8.5 percentage points in May to
7.9 percentage points in June—it remained historically elevated or
significantly above the inflation spike of 2023. (Figure 4, lower graph)
This difference matters because persistent inflation does
not affect all households equally.
Higher‑income households generally possess greater
ability to adjust through changes in consumption patterns, sustained reductions
in savings, or by using accumulated assets to defend against erosion of
purchasing power — for example, buying USD or other inflation‑hedging
instruments.
Lower-income households have far fewer margins of
adjustment.
They continue purchasing the same essential goods—rice,
food, electricity, and transportation—but those costs represent a much larger
share of their available income. Inflation therefore reduces not only
purchasing power but also household flexibility and resilience.
This
perspective exposes inflation’s role as inequality’s engine: a regressive tax
that punishes the poor while averages mask fragility.
This distinction is also important when interpreting
broader economic classifications and averages. Improvements in aggregate
indicators may reflect selective progress, but they do not necessarily capture
how households experience changing prices in their daily lives.
Statistical averages summarize outcomes.
Ironically, the data
defies the conditions
that brought upon the upper middle-income country (UMIC) status upgrade.
That asymmetry becomes even clearer when moving beyond
prices and examining the labor market, where businesses must decide whether
rising costs can still be absorbed or whether they must adjust employment,
investment, and production decisions.
That said, selective liquidity injections and
quasi-bailout dynamics operate as an inflation tax. The redistribution occurs
through the unequal transmission of newly created purchasing power: early
recipients benefit before prices fully adjust, while households with the least
ability to hedge against inflation absorb the greatest loss of purchasing
power. Monetary accommodation therefore functions as a regressive transfer
mechanism, amplifying inequality and social pressures.
IIIC. Benchmarkism and the Illusion of Labor Absorption
The June inflation report reveals where the transmission
of monetary expansion becomes visible. The
May labor report, by contrast, reveals where its longer-term consequences
begin to emerge.
Official commentary described the May labor statistics as
evidence of improving "labor absorption." The phrase itself is
revealing. It suggests that employment expands mechanically once workers become
available, as though the economy simply absorbs labor whenever conditions
permit.
The reality is different.
Employment is not
an autonomous variable. In a market economy, labor demand is derived demand.
Firms do not hire merely because workers are seeking employment. They hire
because entrepreneurs, operating under uncertainty, expect that committing
resources to expand the enterprise will generate future returns.
Employment
therefore represents the outcome of prior investment decisions.
Structural capital
includes not only physical assets and financial resources, but also the organizational, technological, managerial,
and human capital that allow labor
to become productive. Workers become
more valuable when combined with the complementary capital, processes, and
institutions that enable production to occur efficiently.
A labor market can therefore improve through two very
different mechanisms.
The first involves firms utilizing existing deployed capital: filling
vacancies, extending working hours, increasing production within current
facilities, or replacing workers who have exited.
The second involves entrepreneurs committing new capital to expand the
productive structure itself: entering new markets, building additional
facilities, acquiring new capabilities, and creating new organizational
capacity.
It is the second
process that represents the creation of additional productive capacity and
therefore determines the economy's longer-term ability to generate sustainable
employment growth.
Labor statistics,
however, cannot fully distinguish between these outcomes. A reduction in
unemployment or underemployment may indicate improved labor utilization, but it
does not necessarily reveal whether firms are undertaking the deeper capital
commitments required for sustained economic expansion.
The broader investment environment provides a more
cautious picture.
Figure 6
Foreign
direct investment (FDI) has weakened substantially reaching a decade-low level
in April. (Figure 6, topmost pane)
While the recent Iran war oil shock may have contributed
to this, the broader decline in foreign exposure since 2022 suggests increasing
caution among investors considering long-term commitments.
This pattern is notable given the investment pledges
announced during official engagements with geopolitical partners. Announced
intentions do not automatically translate into deployed capital. Actual
investment decisions ultimately depend on expected returns and hurdle rates,
underwritten by institutional conditions, policy stability, and the perceived
risks facing capital commitments.
The divergence between household and business sentiment
reflects a similar tension.
BSP surveys indicate that consumers
remain concerned about rising food prices, declining purchasing power, and
persistent inflation pressures. Large
formal enterprises, by contrast, maintain comparatively stronger
expectations regarding sales and operating conditions. (Figure 6, middle left
and right images)
This divergence partly reflects differences in economic
position. Large firms generally have greater access to credit, capital markets,
export revenues, diversified income streams, and pricing power. Their outlook
may therefore reflect stronger balance-sheet capacity or even narrative
management aimed at securing financial interests, rather than broad-based
improvements in the economy.
Even within business surveys, the signals are mixed.
Firms may express confidence regarding near-term operations while remaining
cautious about major expansion decisions. Ultimately,
investment outcomes—not surveys—determine whether optimism translates into
productive capacity.
The labor statistics themselves also present a more
complex picture than headline indicators suggest.
Compared with April, labor-force participation and unemployment
marginally increased
Compared with May of the previous year, however,
employment and labor-force participation remained weaker.
More importantly, under present high inflation conditions,
labor‑market softness reflects entrenched financing costs, balance‑sheet
strain, policy uncertainty, volatile prices, and compressed margins. (Figure 6,
lowest chart)
Unlike the post‑pandemic reopening inflation spike, when
BSP’s unprecedented injections and fiscal support temporarily fueled pent‑up
demand, today’s environment discourages irreversible capital commitments.
Employment gains in agriculture, construction, and accommodation may be
seasonal or policy‑driven, not evidence of durable expansion.
These conditions do not naturally encourage the
irreversible commitments associated with expanding structural capital.
The sectoral composition of employment gains reinforces
this caution.
Agriculture recorded the largest employment increase
despite recurring weather disruptions and elevated input costs. Construction
also expanded, although some of its momentum may reflect continued government
infrastructure activity rather than broad-based private investment.
Accommodation and food services improved despite tourism in recession in 2025,
as well as earlier reported contractions in Baguio, Boracay, Hundred Islands
and East Visayas.
Such movements may represent temporary adjustments,
seasonal effects, or sector-specific developments.
They do not, by themselves, demonstrate a generalized
expansion of productive capacity.
The labor data is another manifestation of benchmarkism.
Employment, unemployment, and underemployment are
valuable indicators. They measure observable outcomes, but they reveal little
about the entrepreneurial processes that generate those outcomes.
They tell us how many people currently have jobs.
They tell us far less about whether entrepreneurs are
committing scarce capital to create the productive capacity required for future
employment.
That unseen process ultimately determines whether current
labor conditions represent a durable expansion or merely a temporary
improvement within a constrained economic structure.
IIID. Wage Mandates and the Intervention Spiral
Against this backdrop, the Metro
Manila wage board approved a historic Php85 per day increase in mandated
wages, the largest adjustment in years. The measure was presented as a response
to rising living costs and as protection against inflation.
The political appeal is understandable.
The economic challenge is that higher mandated wages do
not restore lost purchasing power. They redistribute the burden of reduced real
income among employers, consumers, investors, taxpayers, and workers
themselves.
The cost does not disappear because it is mandated.
Businesses facing
higher labor costs must adjust through some combination of lower margins,
higher prices, reduced hiring, delayed investment, automation, or
restructuring. The ability to absorb these costs differs significantly across
firms.
Large corporations with stronger balance sheets, broader
revenue sources, easier access to financing, and greater pricing power may
adapt more easily.
Many MSMEs face a
different reality. Operating with thinner margins, limited access to
financing, and fewer opportunities to pass costs forward, smaller firms are
generally less capable of absorbing mandated increases in labor costs.
The effects of
such policies are therefore not distributed evenly across the economy.
Larger enterprises with stronger balance sheets, greater access to capital
markets, established supply chains, and greater pricing power are better
positioned to adjust. For smaller competitors and potential new entrants,
however, higher compliance costs can become additional barriers to expansion.
This creates an
unintended asymmetry. Policies introduced in the name of protecting workers
strengthens the position of established firms by increasing the cost of
competition, while reducing opportunities for smaller enterprises to grow,
train new workers, and create new employment capacity. This creates an implicit protective moat for conglomerates, raising
barriers to entry and reinforcing concentration under the guise of worker
protection.
The consequences extend beyond immediate hiring
decisions. Firms may respond by reducing entry-level opportunities, favoring
experienced workers over new graduates, limiting employee benefits, postponing
expansion, increasing automation where feasible, or remaining informal. These
adjustments reduce the economy's capacity to develop skills, accumulate
enterprise capital, and expand productive output.
When such interventions occur within an environment of
monetary accommodation and expanding liquidity, the adjustment process becomes
even more complex. Higher business costs can contribute to higher prices, while
weaker investment incentives constrain future supply growth. The result is not
simply a labor-market adjustment, but a mechanism through which inflationary
pressures and weaker productive capacity can reinforce one another—stagflation.
Over time, successive interventions can generate a
cumulative process in which attempts to offset earlier distortions create new
distortions requiring further intervention.
Mandated wage hikes redistribute costs but do not restore
purchasing power. Larger firms adapt; MSMEs struggle. The result is an implicit moat for conglomerates, raising barriers
to competition. Within monetary accommodation, higher costs feed inflation
while weaker investment erodes capacity — stagflation in motion. Successive
interventions spiral into quasi‑bailouts, entrenching centralization, weakening
feedback, and deepening rent‑seeking fragility.
IV. Conclusion: Inflation Before Prices
As Ludwig von Mises observed,
what is commonly called inflation today is more accurately the consequence of
inflation rather than inflation itself. The persistent tendency to equate
inflation with rising consumer prices shifts attention away from the monetary
and financial processes that precede those price movements.
The Philippine experience illustrates why that
distinction matters.
Balance sheets reveal where purchasing power is created.
Bank lending reveals where newly created purchasing power is initially
directed. Credit allocation influences investment decisions, resource
allocation, relative prices, and production structures long before those
adjustments become visible in consumer price statistics.
By the time inflation appears in the Consumer Price
Index, the underlying monetary process has often been unfolding for months.
Yet the process does not end with liquidity creation. The
destination of that liquidity matters. When
monetary expansion increasingly operates through the financing of existing
financial pressures, politically significant sectors, or heavily leveraged
structures, liquidity creation can function as a form of quasi-bailout—shifting adjustment costs across balance
sheets rather than allowing those pressures to be fully resolved through market
processes.
The consequence is not merely higher prices.
It is a gradual
weakening of the economy's capacity to adjust. Resources are redirected toward
sustaining existing structures rather than expanding productive capacity.
Price signals are delayed through administrative interventions. Labor
statistics improve without necessarily reflecting stronger capital formation.
Businesses face rising costs while investment incentives weaken.
These developments represent different stages of the same
underlying process.
The BSP's balance-sheet and lending data therefore
provide more than a snapshot of current financial conditions. They reveal the evolving structure through
which liquidity is created, transmitted, allocated, and ultimately reflected in
economic outcomes. June's inflation report, the widening divergence between
headline and core inflation, the burden borne by lower-income households, the
changing character of employment, and the growing reliance on successive
interventions are not isolated developments. They are manifestations of a
broader balance-sheet process.
Understanding inflation therefore requires looking beyond
benchmark statistics. Consumer prices summarize observable outcomes. They do
not explain how those outcomes came into being.
Following inflation means following the money.
It means following balance sheets before price indices,
credit allocation before consumer spending, and institutional incentives before
policy outcomes.
Only by
understanding that sequence can we understand not only why prices rise, but
also why repeated attempts to suppress adjustment can transform monetary
accommodation into a self-reinforcing process of weaker investment, distorted
allocation, and ultimately stagflation.
_____
References: (last 3)
Stagflation Part 11: The Intervention
Ecosystem Behind Moody's and Fitch's Banking Warnings
Stagflation Part 10: The Politics of
Contradiction—Rate Hikes, Liquidity Addiction, and External Constraint Under
Balance-Sheet Stress
Stagflation Part 9: The Good News Mirage —
Statistical Stability Amid Structural Fragility
