A study on Philippine exchange rate policies

Since the late 1960s, there has been strong resistance from many quarters against any form of devaluation, in sharp contrast with the near-unanimous call of economists for a realistic depreciation of the currency in order to encourage exports, foster economic competitiveness and efficiency, and avoid perennial balance-of-payment crises. The diammetrically opposed positions are further polarized today as many in the private sector - - from big business to militant labor and even small farmers -- consistently oppose devaluation. Their resistance has silenced policymakers who espoused realistic exchange-rate adjustments. The private sector sees devaluation as stagflationary: increases in the domestic cost of imports contract output and aggravate price inflation (e.g. Krugman and Taylor 1978). Empirical studies incorporating the exchange rate in a supply-side macro model corroborate the above intuition (see Bautista et al. 1992). This study, however, will try to show that if exchange rates are fixed, then it would be misleading to use them in macro-supply equations to represent the shadow exchange rate, or as the measure of the scarcity of foreign exchange. For in a fixed exchange-rate regime, foreign exchange may be scarce and exchange rates low, so that the exchange rate will not reflect the true economic cost of foreign-exchange scarcity. It is appropriate in this case to include the international reserves as a determinant in output supply, particularly when foreign-exchange controls are implemented (as they usually are) simultaneously with a de facto fixed exchange rate regime.