GINGOOG CITY UNITED COLLEGES

TESTING PHILLIPS CURVE TO EXAMINE THE INFLATION RATE REGARDING UNEMPLOYMENT

RATE, WAGE RATE AND GDP OF PHILIPPINES: 1960-2022

A RESEARCH PROPOSAL SUBMITTED TO

THE FACULTY OF THE ECONOMICS PROGRAM

GINGOOG CITY UNITED COLLEGES

IN PARTIAL FULFILLMENT OF THE

COURSE ECON RC5–RESEARCH 1

BY
GAMIL, JELLY KIETH C.
AWITAN, SHEIRMAE JEAN C.
LUMBAN, BANO
RACINES, WILDON

GINGOOG CITY,PHILIPPINES

September, 2024
 CHAPTER II

REVIEW OF RELATED LITERATURE

This chapter includes related literature and studies from numerous sources following
the researcher’s in-depth search. This is divided into three sections-policy issues, theoretical
literature, and empirical literature.

I. POLICY ISSUES

On discussions about rising inflation, it is helpful to place the present scenario in

historical perspective. Inflation has been far worse: it peaked at an amazingly high 50.3% in
1984 (see Figure 1). So let's put recent inflationary shock into perspective; we have endure
much worse rates in the past.

Figure 1: Historical PH inflation rate (1961-2017)

Source: PSA, Base year 2006

From Figure 1, it is possible to determine that the levels of inflation had been doubled
during the period of Marcos, several record-breaking peaks reached 21.4% in 1971, 34.2% in
1974, and 50.3% in 1984. For most Filipinos, social and economic poverty marked the
period from 1975 to 1986 as this was the time when Marcos pushed through with massive
government spending since his first term. He also followed protectionist industrial policies
from the past. That meant imports continued staying substantially ahead of exports. Both
these policies drained our foreign currency reserve to perilous levels in the late 1960s
(Rappler, 2018)

This trend, however, was reversed in the mid-1970s, and by 1980, unemployment had
risen to 7.9%. The inflationary proclivities became a concern as well; inflation rose from
7.1% in 1975 to 17.4% by 1980. It became worse between 1981 and 1985, with average
unemployment pegged nearly at 11%, peaking at 12.6% in 1985. Inflation went over 20
percent that period and hit 47 percent in 1984. As of 1985, a majority had to live below
poverty level; that was up to 75 percent, with 49 percent classified extremely poor (IBON
Foundation, 2016).

4.5 Figure 2: Unemployment Rate (%)

4 Unemployment Rate (%)
3.5

2.5

1.5

0.5

0
60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14 17 20
19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20

Source: Macrotrends

The COVID-19 pandemic has significantly affected the labor market in the
Philippines, leading to an unprecedented spike in unemployment and highlighting underlying
vulnerabilities. Although the unemployment rate has decreased since its peak in April 2020,
the recovery remains inconsistent, with many of the new jobs being of lower quality
compared to pre-pandemic levels.
 To address these challenges, the Philippine government initiated the National
Employment Recovery Strategy (NERS) on May 1, 2021. This strategy aims to enhance
access to employment, provide livelihood and training opportunities, and support both
existing and new businesses to generate sustainable job opportunities in the wake of
pandemic-related job losses.

The NERS program employs a programmatic approach that utilizes policy-based

loans across two subprograms, focusing on sustainable business practices and labor market
recovery. This effort reflects a broader commitment to rebuilding the labor market and
ensuring a more resilient economy as the country navigates post-pandemic challenges
(Muhammad, 2021).

The COVID-19 pandemic caused severe job losses in the Philippines, with
approximately 10.9 million workers either unemployed or facing reduced working hours and
incomes. Vulnerable sectors like manufacturing, transportation, food services, and
entertainment were the hardest hit, and about two-thirds of affected workers may be
permanently displaced as the economy shifts towards online operations. The International
Labor Organization (ILO) highlighted that underemployment surged, and income losses have
pushed millions into poverty. The ILO recommends strengthening social protection,
employment programs, and support services to help reintegrate workers into the labor
market.

Figure 3: Gross Domestic Product

USD Billion
 Source: World Bank

During the COVID-19 pandemic, gross domestic product (GDP) decreases

drastically, and inflation is very severe. During 2020, the country's GDP shrank by 9.6%,
marking its largest contraction since 1946. Key factors included reduced household
consumption and a sharp drop in exports and investments. However, the economy showed
signs of recovery in 2021, with the ADB projecting a 6.5% rebound as restrictions eased and
government support increased. Inflation also posed a challenge during this period, driven by
disrupted supply chains and heightened demand post-pandemic.

Philippine Gross Domestic Product (GDP) continues to show an impressive growth of

6.3 percent in the second quarter of 2024 relative to its corresponding period the previous
year. These sectors were Construction at 16.0 percent; Wholesale and retail trade, and motor
vehicle and motorcycle repair, at 5.8 percent; and Financial and insurance activities at 8.2
percent. Among the key sectors, Industry increased by 7.7 percent and Services by 6.8
percent; Agriculture, forestry and fishing fell into an annual decrease of 2.3 percent. Growth
in GDP was led mainly by the growth in Household Final Consumption Expenditure which
increased by 4.6 percent. Other expenditures that were driven by year-on-year growth include
Government Final Consumption Expenditure that grew to 10.7 percent; Gross capital
formation showed growth at 11.5 percent; and Exports of goods and services rose 4.2 percent,
while Imports of goods and services increased by 5.2 percent (Philippine Statistics Authority,
2024).

Figure 4: Wage Rate 9(PHP/Day)

WAGE RATE (PHP/day)

600

500

400

300

200

100

0
60 963 966 969 972 975 978 981 984 987 990 993 996 999 002 005 008 011 014 017 020
19 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2
 Source: Trading Economics

The wage rate in the Philippines has consistently increased over the decades, as
demonstrated by the data in figure 4. The most significant growth began in the late 1980s
following the Marcos era, with the introduction of the Wage Rationalization Act (Republic
Act No. 6727) in 1989, which set up the National Wages and Productivity Commission
(NWPC) to regulate wage rates across the country. Since then, wage adjustments have been
determined regionally, with increases linked to inflation and economic conditions. For
instance, by 2015, the daily minimum wage in Metro Manila was P466, while recent data
shows it has continued to rise, reflecting economic adjustments.
II. THEORETICAL LITERATURE

2.1 Phillips curve

The Phillips curve argues that maintaining a low unemployment rate can result in upward
pressure on inflation. This relationship was first identified in 1958 by New Zealand
economist A. W. Phillips. Over time, the Phillips curve has been reinterpreted to describe the
connection between changes in inflation rates and unemployment (Blanchard & Johnson,
2013). It serves as a foundation for understanding the link between inflation and
unemployment, suggesting a negative correlation between the two. According to economic
theory, there is a positive correlation between the inflation rate and both the annual wage rate
and GDP, while unemployment is negatively correlated with inflation. In line with the
Phillips curve, an Ordinary Least Squares (OLS) model was constructed to capture the
symmetric relationship among inflation, unemployment, annual wage rate, and GDP in the
Philippines from 1950 to 2017. The model is expressed as follows:

πt=α+β0+β1ut+β2wt+β3gt+ϵt (1)

Where:

● πt represents the inflation rate

● α is the constant term (alpha coefficient)
● β0 indicates the baseline effect on inflation and unemployment
● β1, β2, and β3 are coefficients for unemployment, wage rate, and GDP, respectively
● ut, wt, and gt stand for unemployment rate, annual wage rate, and GDP
● ϵt is the error term.

To estimate short-run dynamics, an Error Correction Model (ECM) was developed,

represented by:

Δlnπt=α0+α1Δlnut-i+α2Δlnwt-i+α3Δlngt-i+Δlnπt-1+α4Ut-1+ϵt (2)

Where:

● Δ indicates the first difference of the logarithms of the variables

● Ut-1 represents the error correction term derived from the long-run co-integration
equation:
 Ut-1=lnπ2t–β0–β1lnUt–β2wt–β3gt

Here, Ut-1 corrects for deviations from the long-run equilibrium, α4 is the error correction
coefficient, and

αi are the short-run coefficients as estimated by the model (Jammeh, 2012).

2.2 Keynesian theory

The two curves that are basically described under the traditional Keynesian model are
the Aggregate Demand (AD) curve, and the Aggregate Supply (AS) curve. As such, the
relationship between inflation and economic growth (GDP) can then be effectively described
through such a model of Keynesian theory. Basically, according to the original Keynesian
theory, changes in aggregate demand-whether expected or unexpected- would impact real
output and employment more than the prices in the short-run. For example, this type of idea
is portrayed in what are called Phillips curves. Such a Phillips curve shows that inflation
arises only slowly when unemployment falls. In short run," they say, "what is true need not
be true in the long run, and we live in the short run." They enjoy quoting Keynes' statement
that has come to be famous, "In the long run, we are all dead," in making their point.

III. EMPIRICAL LITERATURE

Unemployment Rate and Inflation Rate

The Phillips curve relationship, described by William Phillips in 1958, is a

fundamentally negative relationship between inflation and unemployment, meaning that
policymakers have to face a trade-off between these two macroeconomic variables.
Empirical studies on the Phillips curve have been a crucial subject of study for many years in
developing economies. According to Naqibullah et al. (2020) in their titled study "The Long-
Run Determinant of Inflation in Malaysia: A Phillips Curve Review," conducts an
investigation into the long-run relationship cause between unemployment, UNE, and
inflation, INF in Malaysia. The causative association indicates a relation with a negative
long-run relationship between unemployment and inflation. Thus, the results further provide
confirmation of the existence of the long-run Phillips curve phenomenon whereby
unemployment causes inflation. The findings based on the analysis suggest that whereas
unemployment is a fundamental long-term determinant of inflation, short-term movements in
unemployment do little to influence inflation. Hence, it would mean that policymakers
should be focusing more on long-run approaches toward controlling inflation and its
unemployment counterpart rather than trying to move between the two short-run in particular
because short-run interventions may not bring the desired trade-offs. The authors use the
ARDL bound test for cointegration, the Error Correction Model (ECM) for long-term
relationships, and the Wald test to establish short-term causality from 1991 to 2018.

Meanwhile, as Elliot (2015) suggests, in their study titled "The Relationship

between Inflation and Unemployment in Ghana: Analysis of the Phillips Curve," the
research subjects analyze the inflation and unemployment relationship of Ghana and test the
validation of the Phillips Curve by employing the New Keynesian Phillips Curve model.
Based on the periods studied of the sub-sample (1970–1982 and 1983–2013), the author
found out that changes in unemployment result in no change in inflation, pointing out there
is not significant evidence proving to be on favor of the Phillips Curve in the context of
Ghana. The author made use of annual time series data over the period 1970-2013 split into
two separate subsamples in testing for effects of the Economic Recovery Programme on the
inflation-unemployment relationship. Empirical estimations had involved two stages - that
had been the estimation of inflation inertia coefficients and the output gap by using this as a
measure for unemployment.

The empirical evidence suggests that structural characteristics like a rapidly

growing labour force with inappropriate skills and high rural-urban migration hinder
unemployment to respond to changes in inflation. Overall, the research scope will
incorporate a comprehensive review of Ghana's economic context over a significant time
frame to portray the inadequacy of using the Phillips Curve as a policy instrument for
inflation and unemployment control in Ghana. Meanwhile, there is study highlighting
unemployment significantly affecting inflation, as both threaten any economy. Some
economists believe that low unemployment will increase inflation, but other economists
argue that this is only in the short run. For India, unemployment relates to a loss of output
since the unemployed person does not have the effect of producing anything or paying taxes
which affects those paying their dues. Using a bi-variate regression model, this study
suggests there is no relationship whatsoever between unemployment and inflation in India.
This supports the null hypothesis. Some recommendations for policy would include focusing
on local economic growth, a plan to develop advanced technology that could create jobs,
raise wages, ensure price stability, and also the infrastructure, especially electricity, which
could create much more employment opportunities (Xia, 2021). Abu, 2019 says that there is
a trade-off between factors, where long-run unemployment leads to lower inflation in
Nigeria. However, Orji et al. (2015) presents an argument that unemployment remains one of
the basic driving forces of inflation because there is a positive correlation between the
inflation rate and the unemployment rate in Nigeria. Zayed et al. 2018 investigated if the
Phillips curve exists in the Philippines. In the process of the study, they had developed a
model to work through the long-term relationship between the relevant variables and the
Phillips curve. Chletsos et al. (2016) studied the case of the Phillips curve in relation to
inflation prediction for both the U.S. and Canada from 1960 to 2013 based on a model with
constant and standard coefficient. They showed that inflation was indeed unstable in both
countries and that adding time-variation modeling could, in all likelihood, improve the
accuracy of predictions for the US but not likely for Canada. Seydl & Spittler (2016)
introduced the latest evidence of the flattening of the Phillips curve in standard econometric
models. Arguably, both the labor and the product market wages growth have been curtailed
so that this has been creating income inequalities. This also relates to an unemployment rate
of less than what is measured in the U.S. at what is seen as full employment.

Gross Domestic Product and Inflation Rate

According to Xiong (2023) in the research study "Relationship Between GDP
and Inflation Rate" discovered that there is a significant negative relation between inflation
and GDP growth. Inflation tends to act as a drag on productivity and slows down economic
expansion. In fact, he was studied in terms of regression analysis to estimate how inflation
varies with respect to GDP. A paradigm with several output responses is developed and
considered, under which the connection between economic progress and pricing is depicted.
The real GDP of the Philippines has increased remarkably over the last decades and has
evidenced upward general growth. According to a poll of economists from Bloomberg, the
country Philippines is one of the world's fastest-growing economies and second only to
China in 2015, with forecasted growth at 6 percent or more (Robinson, 2015). Lagad (2022),
the results of his research "GDP of Indian Economy and Its Impact on Inflation" found that
population growth has a significant influence on GDP explaining 90% of its variation,
whereas inflation explains 99%. His research ends with the point that population growth and
inflation both are responsible for having high impacts on the Indian economy. Positive trends
in these variables bring growth of the GDP. "Correlation and Regression analysis, t-tests, and
the ANOVA model based on 20 years of data obtained from secondary sources such as RBI
and World Bank reports analysed using SPSS M.G. Anghel et. Al (2017), have concluded
that a strong inverse relation does exist between the National Gross Domestic Product and
the national rate of inflation, meaning that high inflation levels decrease GDP growth. The
analysis showed that periods in which inflation is higher, tend to witness a decline in GDP,
although there were few cases of inflation stabilization during periods from 2014 to 2016,
due to administrative measures. The researchers applied simple linear regression as their
method, with conclusions that this econometric model is effective for relationships between
GDP and inflation in Romania and offers a trusted insight into analysis for national
macroeconomic management.

Wage Rate and Inflation Rate

According to Majchrowska (2022), in the research titled "Does the Minimum
Wage Affect Inflation?", it has been observed that impacts of minimum wage vary with time
and regions. Their more significant effects in terms of inflation are faced during high
inflationary periods rather than low inflationary periods due to some increases in minimum
wages. Not only does this, but it also puts greater inflationary pressure in areas with strong
labor markets and higher wages. This is particularly so in urban regions such as Mazovia,
Silesia, Pomerania, Lesser Poland, and Greater Poland where competition between
employers is heightened.

Recent studies indicate mixed results for the minimum wage growth rate and its
influences on inflation; however, most do not indicate an increase in the minimum wage
could ignite inflation. Results from studies by Campos-Vazquez and Esquivel (2020), “The
effect of doubling the minimum wage and decreasing taxes on inflation in Mexico”
investigated the combined effect of a quarter on point increase of the minimum wage, a
doubling of it, and a reduction of VAT on Mexican municipalities in 2019. They
demonstrated that the effect of VAT reduction overpowered the effect of the minimum wage
increase in cutting inflation for the year. The estimates say that the impact of this increase in
the minimum wage was either very minor or insignificant in their estimation. On the
empirical side, the results from the estimations undertaken by MacDonald and Nilsson
(2016) show that the impact of the minimum wage hikes on prices is considerably smaller
than the effects reported in previous studies. It is mainly taking place during the month in
which the wage increase occurred. It will positively confirm the existence of an effect of
minimum wage increases on prices, statistically significant.