1. Capturing the Linkages Between Real and Financial Variables: The Global Projection Model for the Philippines Ruperto Majuca and Joy Sinay

2. Real and Financial Variables Developments in the financial markets affect the real economy and vice-versa Effects on liquidity, balance sheets, and the capacity of the financial sector to perform its typical intermediation functions Financial accelerator, flight to quality 2008/2009 global recession; Philippine case

3. Comparison of Approaches Classical estimation, simultaneous equations, VAR/SVAR/GVAR Dynamic stochastic general equilibrium (DSGE) modeling and estimation (e.g., Majuca 2011) Global projection models

4. GLOBAL PROJECTION MODEL Global Projection Model (GPM) aims to integrate the world economies. GPM will enable researchers to analyze the effects of shocks in one country and of global shocks to home economy and to the rest of the economies integrated in the mode. It will give forecasters a new tool to assist them in preparing worldwide forecasts and in carrying out alternative policy simulations in the global context.

5. Estimation Techniques Calibration Maximum likelihood Bayesian methods (combination of prior and data) Kalman filter Markov Chain Monte Carlo

6. GPM 3 + Philippines Model Potential Output NAIRU Equilibrium Real Interest Rate

7. GPM STOCHASTIC EQUATIONS Equilibrium Real Exchange Rate Output Gap (Aggregate Demand / IS Curve) Inflation (New Keynesian Phillips Curve)

8. BEHAVIORAL EQUATIONS Policy Interest Rate (Taylor Type Rule) Uncovered Interest Parity (Bilateral Real Exchange Rate) Unemployment Rate Equations Incorporating BLT_US

9. EQUATIONS INCORPORATING BLT_US MODIFIED EQUATIONS FOR PHILIPPINES Equilibrium Real Exchange Rate Inflation Rate Uncovered Interest Parity

10. MODIFIED EQUATIONS FOR PHILIPPINES Interest Rate

11. VARIANCE DECOMPOSITION Top three sources from each country (in percent) RES_RS_PH RES_Y_PH RES_PIE_PH RES_Y_EU RES_RS_EU RES_PIE_EU RES_BLT_US RES_G_US RES_Y_US RES_Y_JA May 7 Y_PH41.9326.7413.662.040.850.753.82.461.480.84 GROWTH_PH19.7868.12.450.710.260.191.080.70.780.54 GROWTH4_PH39.6536.136.571.780.720.552.931.91.420.88 RR_PH78.162.298.80.670.330.523.0920.520.27 May 31 Y_PH25.9437.2717.41.530.680.693.352.170.820.58 GROWTH_PH7.8678.442.90.450.180.140.690.450.290.28 GROWTH4_PH20.2047.918.721.330.570.482.241.460.710.57 RR_PH54.154.921.010.610.310.513.051.980.390.25

12. RESULTS US affecting PH Bank Lending Tightening RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

13. RESULTS US affecting EU Bank Lending Tightening RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

14. RESULTS US affecting JAPAN Bank Lending Tightening RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

15. RESULTS US Bank Lending Tightening RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

16. RESULTS Japan affecting PH INFLATION RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

17. RESULTS EU affecting PH INFLATION RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

18. RESULTS US affecting PH INFLATION RS Nominal Interest Rate RR Real Interest Rate

19. RESULTS US AFFECTING PH INTEREST RATE RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

20. RESULTS EU affecting PH NOMINAL INTEREST RATE RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

21. RESULTS Japan Affecting PH NOMINAL INTEREST RATE RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

22. RESULTS US Affecting PH NOMINAL INTEREST RATE RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

23. RESULTS EU affecting PH Real Exchange Rate RS Nominal Interest Rate RR Real Interest Rate REER

24. RESULTS JAPAN affecting PH Real Exchange Rate RS Nominal Interest Rate RR Real Interest Rate REER

25. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

26. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

27. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

28. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

29. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

30. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

31. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

32. RESULTS Demand Shock RS Nominal Interest Rate RR Real Interest Rate REER

33. Conclusions and Future Work, 1 Philippine economy receptive to shocks from other countries Bank lending conditions in the U.S. affect the Philippine real economy Estimation results detail how conditions in U.S., EU, Japan affect domestic economy Interactions between the financial and real variables are important and captured by the model

34. Conclusions and Future Work, 2 China incorporated in future work (five country framework) Oil and other important shocks may be incorporated Structure shift (Markov switching)

35. RESULTS RES_RR_DIFF_JA4 Difference Between the Real Interest Rate In Countryi and its Counterpart RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

36. RESULTS RES_LGDP_BAR_PH Real GDP

37. RESULTS RES_G Growth

38. RESULTS RES_G_US4 GROWTH RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

39. RESULTS RES_RR_DIFF_PH Difference Between the Real Interest Rate In Countryi and its Counterpart RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

40. RESULTS RES_Y_EU4 OUTPUT GAP RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

41. RESULTS RES_Y_JA4 OUTPUT GAP RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

42. RESULTS RES_Y_PH OUTPUT GAP RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

43. RESULTS RES_Y_US4 OUTPUT GAP RS Nominal Interest Rate RR Real Interest Rate REER Real Exchange Rate

44. Conclusions GPM6 database for GPM3 countries –Consumer price index –Real gross domestic product –Nominal interest rate –Nominal exchange rate –Unemployment rate –Bank lending variable for US Philippine data for Philippine block (compared with GPM6 data for Philippines to verify) –All data are seasonally adjusted –CPI, GDP and ER are in logs

45. ESTIMATION GPM6 database for GPM3 countries –Consumer price index –Real gross domestic product –Nominal interest rate –Nominal exchange rate –Unemployment rate –Bank lending variable for US Philippine data for Philippine block (compared with GPM6 data for Philippines to verify) –All data are seasonally adjusted –CPI, GDP and ER are in logs

46. The Global Projection Model for the Philippines Thank you!

47. RELATED LITERATURE Peiris, Shanaka J. (2011), IMF A Forecasting and Monetary Policy Analysis System (FPAS) for the Philippines –High estimates for foreign output gap show significant trade, particularly with US –High impact of lead inflation on inflation rate indicate strong impact of monetary policy on price expectations –A very high impact of inflation on nominal interest rate, indicate inflation targeting framework

48. RELATED LITERATURE Ramayandi, Arief (March 2011), ADB Impact of financial shocks on four small open economies (Malaysia, Indonesia, Thailand, Philippines) –Habit persistence is high in the Philippines (consumption patterns) –Inflation in Indonesia and Philippines decline most with a shock to external interest rates –Philippine inflation returns to steady state faster and becomes positive (unlike the other three countries) –Philippine output gap has the least volatility to the external interest rate shock –Impact of shock is more apparent in inflation than in the output gap (for Philippines) –Monetary policy is more responsive to output gap than to inflation

49. MONETARY POLICY AND KEY VARIABLES Inflation Targeting Framework: In the Philippines, the Bangko Sentral ng Pilipinas (BSP) follows the inflation- targeting framework for monetary policy. Inflation is the primary concern, but some consideration is given to stabilize output close to potential output. Inflation targets are announced two years beforehand.

50. RELATED LITERATURE Melander, Ola (2012), IMF Spillover effects of financial volatilities in Europe and US on Philippines –Main transmission channels: exports, remittances, portfolio and other capital inflows –Bayesian VAR model –External growth shocks impact more than financial shocks –Shocks are transmitted mainly through the trade channel –Since January 2002 –Failure of monetary aggregates targeting to take into account the time lag in the impact of monetary policy –4.4% inflation in 2011 from 2000-based CPI, within government’s target range

51. MONETARY POLICY AND KEY VARIABLES Floating Exchange Rate System –Market-determined exchange rates –BSP maintains stability in the rates –BSP also provides liquidity and ensures availability of foreign currency –Average of Php43.31/USD1 exchange rate in 2011 –Exchange rate buoyed by strong remittance inflows, foreign direct investments, and net portfolio investments

52. MONETARY POLICY AND KEY VARIABLES Interest Rate: Overnight Reverse Repurchase Rate –One of BSP’s primary monetary policy instrument, the other one is the overnight repurchase rate –Influence money supply and prices –Interest rates are stable given the inflation targeting framework

53. DATA GPM6 database for GPM3 countries –Consumer price index –Real gross domestic product –Nominal interest rate –Nominal exchange rate –Unemployment rate –Bank lending variable for US Philippine data for Philippine block (compared with GPM6 data for Philippines to verify) –All data are seasonally adjusted –CPI, GDP and ER are in logs

54. DATA

56. Unemployment Rate (UNR)

57. Real Exchange Rate (LS)

58. Interest Rate (RS)

59. Real Consumer Price Index (LCPI)

60. Real Gross Domestic Product (LGDP)

61. Prior meanPost. mean May7May31 alpha1_PH0.750.755 alpha2_PH0.10.114 alpha3_PH0.50.500 beta_fact_PH0.150.2830.180 beta1_PH0.650.5590.573 beta2_PH0.150.1320.106 beta3_PH0.150.1370.129 gamma1_PH0.750.7830.867 gamma2_PH1.10.9380.768 gamma4_PH0.50.4420.521 growth_PH_ss54.8174.993 lambda1_PH0.50.5680.580 lambda2_PH0.40.3500.580 lambda3_PH0.050.0830.105 lambda1_RS_PH0.50.3700.465 phi_PH0.60.6690.670 Pietar_PH_ss/ 4.7144.684 rho_PH0.50.4120.488 rr_bar_PH_ss2 / 1.52.1281.471 tau_PH0.050.0470.048 beta_reergap_PH0.050.0470.041 chi_PH0.050.0510.050 RESULTS FROM ESTIMATION

62. Prior MeanPost. Mean May7May31 standard deviation of shocks RES_PIETAR_PH0.250.1920.138 RES_PIE_PH33.0793.307 RES_Y_PH0.50.5440.695 RES_RS_PH0.61.0160.429 RES_LGDP_BAR_PH0.20.2950.155 RES_G_PH0.10.1160.144 RES_RR_BAR_PH0.20.3180.143 RES_UNR_GAP_PH0.60.853 RES_UNR_BAR_PH0.10.133 RES_UNR_G_PH0.10.089 RES_LZ_BAR_PH57.3316.669 RES_RR_DIFF_PH10.9720.652 RES_DOT_LZ_BAR_PH0.10.0790.085 correlation of shocks RES_Y_PH,RES_G_PH0.250.24090.257 RES_LGDP_BAR_PH,RES_PIE_PH0.10.10860.100

63. GPM as of May 31, 2012 Shock to RES- BLT_US

64. GPM as of May 31, 2012 Shock to RES_RS_U S

65. GPM as of May 31, 2012