The macroeconomics of remittances: The case of the Philippines
The aggregate data on global remittances flows hide large differences between countries; remittances are rather concentrated. The amount of remittances received by the top 20 remittances receiving developing countries accounts for about 60 percent of all remittances going to developing countries.4 Expressed as percentage of GDP, for the top 20 remittances receiving developing countries, remittances account for more than 10 percent of GDP (for the total group of developing countries remittances are equal to about 2 percent of GDP). For countries where remittances are an important financial flow the fluctuations in remittances will pose macroeconomic problems. Just like most developing countries have to adjust to reduced capital flows after the global financial crisis, remittances receiving countries will have to adjust to reduced inflows. In this chapter we are particularly interested in the impact of fluctuations in remittances flows on financial markets and on macroeconomic variables and the challenges this sets for macroeconomic policy, in particular for monetary policy. Fluctuations in remittances have direct and indirect effects on variables that the monetary authorities target, such as aggregate demand (and thus the output gap), inflation and the exchange rate. Shocks to remittances also have an impact on the domestic interest rate, thus affecting the instrument the monetary authorities is targeting. When remittances are substantial and fluctuations in remittances significant, such impacts will affect the conduct and the effectiveness of monetary policy. Globalization exposes developing countries to the volatility of international markets. In the literature on financial globalization there is considerable attention for the volatility of capital flows (e.g., Prasad et al. 2003). The surges of inflows and flight of capital have severe effects on the economy. In many developing countries remittances are a financial flow that is as important, and in some cases more important, as capital flows. It is often noted that remittances are more stable than capital flows to developing countries but even so also remittances are subject to shocks. The ups and downs of capital flows and remittances have direct effects on aggregate demand, on the liquidity of financial markets, on foreign exchange markets, etc. In other words, the volatility of financial flows creates significant challenges for monetary policy makers. Some studies suggest that remittances are counter-cyclical; increasing during hard times at home and thus providing an automatic stabilizer that reduces the need for monetary policy action. Other studies, however, suggest a more pro-cyclical pattern. In this chapter we will make two contributions to these discussions, using the experience of the Philippines. First, we will explore statistically the cyclical dynamics of remittances to the Philippines and, second, and more importantly, we will analyze the macroeconomic impact of remittances and the monetary policy implications. Remittances are a crucial financial flow to the Philippines: in recent years annual inflows amounted to 10 percent of GDP. We will use a correlation analysis and Granger causality tests to assess the cyclical dynamics of remittance flows to the Philippines. We find that remittances are strongly pro-cyclical with economic activity in major host countries,
such as the USA. Remittances are also pro-cyclical with Philippine real GDP. In the second endeavor we analyze monetary policy behavior in a quarterly structural macroeconometric model for the Philippines (see Bayangos 2007). To a large extent, our macro model shares features with that of the New Keynesian model (see Ball 1999) that assumes inflation and output to be backward-looking. We have also assumed that there is excess capacity in the economy and the asset markets are imperfect. Central to our macro model are important nominal rigidities in describing the Philippine macroeconomy. In addition, there are lags in the transmission mechanism. In the benchmark version of the model, remittances are exogenous and do not affect monetary policy. In a new version of the model, developed for this chapter, we have made remittances endogenous. Shocks to remittances arise from the business cycle in the main host countries (the USA) and these shocks have an impact on disposable income, personal consumption, money supply, the domestic market interest rate and the labor force. We simulate the impact of a shock to US GDP on the Philippine economy in the two versions of the model. Our results show that the impact is very different when remittances are included in the model and that the appropriate monetary policy response is significantly different. The chapter is organized as follows. The next section goes over the relevant literature on remittances and discusses their determinants and impacts. Section 13.3 provides some basic information on remittances with regards to the Philippines. Section 13.4 estimates the cyclicality of remittances and the subsequent sections introduce the model and the model simulations. The final section concludes.