The Sources of Business Cycle Fluctuations in the Philippines

The objective of the paper is to estimate a structural model of the Philippine economy using vector autoregression (VAR) methodology. The structural model being estimated is a traditional Keynesian AS-AD model of macroeconomic fluctuations. This model predicts that in the short-run, transitory shocks (in the structural VAR model), interpreted as aggregate demand shocks, move output and prices in the same direction and are neutral with respect to output in the long-run, but affect prices. On the other hand, permanent shocks, interpreted as aggregate supply shocks, raise output and lower prices in the short- and long-run. A reduced form bivariate VAR (in output and prices) for the Philippines is estimated, and iversion of the estimated VAR yields a decomposition of output and prices into a moving average of orthogonal output and price shocks. Since this is a reduced-form model, no structural interpretation can be given to the estimates. Restrictions based on theory are imposed, and the resulting impulse response functions and variance decompositions are analyzed within the context of a structural AS-AD model. Impulse-response functions and variance decompositions reveal that output is mostly driven by supply (permanent) shocks, while prices are mostly driven by demand (temporary) shocks. The results appear to be consistent with a relatively steep short-run aggregate supply curve and therefore with rapid price adjustment and an absence of price and/or wage rigidities.