The Philippines’ inflation rate soared to 6.4% in August 2018—the highest since 2009. What are the reasons for the price increase? Can blockchain mitigate these forces that affect inflation?
What is inflation?
Inflation is the overall increase in the prices of goods and services in the market. It is the primary cause why the value of money decreases. Picture this: in the 1960s, you can eat in Max’s Restaurant and order one whole chicken for the amount of P5. Today at the same restaurant, a whole chicken will cost you about P390.
Inflation is caused by different factors that affect the dynamics of supply and demand. An increase in the price of raw materials such as oil and fuel can lead to the increase of business expenditures. The increased cost of production is passed on to the consumers, and this is called cost-push inflation. Similarly, a tax cut can trigger a demand-pull inflation because it gives people more disposable income. The rise in demand can be followed by price hikes. Further, inflation can happen when the government prints more notes or increases its national debt. There will be more money in circulation going after the same goods, and this can trigger prices to rise. As a result, people end up paying more money for the same products.
How does the government control inflation?
Some of the policies implemented by governments are the following:
- Monetary policy. This refers to the set of fixed interest rates. With higher interest rates imposed, the demand will be reduced. Low demand can cause the inflation rate to decrease, but this may also stunt a country’s economic growth.
- Control of the money supply. Another way to control inflation is to limit the circulating supply of money. If less money moves around, spending will also be limited and controlled. Demand will decrease and the inflation rate may decrease as well.
- Supply-side policies. Government implement policies to increase competitiveness and efficiency of the economy.
- Fiscal policy. A government may impose a higher rate of income tax, thus reducing the ability of the public to spend. This can eventually result in a reduction in spending and less inflationary pressures.
In the country, the Banko Sentral ng Pilipinas (BSP) controls inflation by adjusting the interest rate for its overnight reverse repurchase (RRP) facility. This leads to movements in market interest rates, thus affecting the demand of households and firms for goods and services.
How did the Philippines’ inflation grow to 6.4%?
In December 2017, Pres. Rodrigo Duterte signed the Republic Act 10963 or Tax Reform for Acceleration and Inclusion (TRAIN) Law. This is the first package of the Comprehensive Tax Reform Program (CTRP) that intends to cut down poverty rate to 14% by 2022. It immediately took effect in January 2018. The reduction of personal income tax was the most advertised component of the TRAIN law. However, there are two other components that have not been strongly publicized to the people because the provisions obviously negate the extra income brought about by this tax cut. These are the expanded VAT and the increase in excise tax for petroleum products.
The expanded VAT has removed certain sectors and transactions from being VAT–exempt, including the sale and transmission of electricity. The tax hike for petroleum products has caused a confluence of cost-push factors to steer the inflation upwards. Lo and behold, the extra income that a worker takes home from the tax cut was canceled out by price hikes in transportation, electricity and food.
Since then, the country’s inflation rate has experienced a steady upward trajectory. The Department of Finance (DOF) estimated around 0.73 percentage point increase in inflation during the first year of implementation. However, it is apparent that the rate of increase exceeded the estimate projected. Inflation has grown to 3 percentage point within 7 months. (Data were taken from the Philippine Statistics Authority.)
External forces like global oil price hike can also be considered as one of the factors for the increase. Nevertheless, the said factor on its own is not capable of causing the inflation rate to soar at this level. It is the government who actually caused the accelerated cost-push inflation by introducing additional levies to petroleum products. It has also injected more money into the economy thru income tax cuts which resulted in a demand-pull inflation. The misguided TRAIN law has jump-started the inflation rate we are experiencing today.
What is blockchain?
Blockchain is a public, secured and decentralized registry that stores assets and transactions in a peer-to-peer network. It allows people to transact with each other without the need for a middleman or a trusted institution. There is no central authority maintaining the system. Instead, the computers on the network maintain the same copy of the registry by running the same software that heavily relies on cryptography and mathematics to secure the system and achieve consensus on the current state of the registry.
Using blockchain to reduce cost-push inflation
Blockchain is a new mechanism for exchanging transactions in a peer-to-peer manner. It allows two parties to directly trade with each other without the need for a middleman or a trusted institution in between. Cost-push inflation occurs when production decreases and products and services become limited mainly due to the price increase in raw materials.
The factors that affect the price change in raw materials can be hard to control, but creating a blockchain-based marketplace for the raw materials to be openly traded can reduce the cost of acquiring them. First, this will remove all the intermediaries involved in the process, thereby cutting down markup fees. Second, the fees involved in processing the payments can be significantly reduced since the money or asset ownership moves within the decentralized network and it is only dependent on a single transaction fee imposed by the platform.
Using blockchain to reduce demand-pull inflation
The government can trigger a demand-pull inflation by injecting more money into the economy in several ways such as reducing tax, printing more money and acquiring more debts.
Creating a public and decentralized blockchain-based currency backed by bitcoins can control the government from inflating its currency. Bitcoin is inflationary and limited. There will only be 21 million bitcoins available. No entity can arbitrarily create bitcoins, its monetary policy is defined in its source code and it will be very difficult to change it. Because of its open-source nature, no government can easily influence or direct its policy.
All governments can print money at will. The Bangko Sentral prints money annually, and the volume or value of the currency to be issued is projected based on currency demand that is estimated from a set of economic indicators which generally measure the country’s economic activity. Using an inflationary currency can stabilize the demand and reduce the risk of economic instability.
The country is also in a hysteria of consumer spending. People spend on things that they don’t need. This is due to the fact that money is not scarce anymore; and the people, especially the middle-class, are endowed with greater purchasing power. If a government can implement a bitcoin-based cryptocurrency, people will be more prudent in spending.
A public and decentralized blockchain can be used to govern an economy. Monetary policies, inflation, and taxation can be defined and automated. It offers more transparency and lessens the concentration of power to a single entity like the central government. If used correctly, blockchain can actually heal a government plagued by incompetent and corrupt people.