Which to watch? Inflation vs exchange rate


Which to watch? Inflation vs exchange rate

...stakeholders weigh in on the matter

Business reporter

Wednesday, November 20, 2019

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The Bank of Jamaica (BOJ) and the Government, as a part of the country's monetary policy direction, have taken the decision to focus on inflation targeting instead of foreign exchange (FX) movement.

This approach is deemed more prudent as inflation targeting focuses more on domestic considerations which are better able to respond to shocks in the market. This is not possible under an exchange rate system.

The exchange rate system looks at just one price of one currency in comparison to another, while the inflation rate is the cost price of many goods consumed by citizens grouped together in a basket.

Noting that inflation affects everyone directly, government and economic experts have thought it wise to track and give key focus to this measure.

They are of the view that while many Jamaicans tend to see health of the economy as integral to the dollar's value, this should not be the case as inflation targeting is a better measure as the repercussions are more direct. Through its inflation targeting framework, the central bank has opted to track, monitor and maintain low and stable inflation within its prescribed medium range of 4.0 per cent - 6.0 per cent.

Prime Minister Andrew Holness recently reiterated the Government's position in support of inflation targeting over foreign exchange.

Given the volatile movement of the Jamaican dollar within the last couple of days, the prime minster has sought to comfort the fears of many Jamaicans who have become concerned about the sporadic depreciation of the Jamaican dollar.

The Business Observer in its quest to get a general view on what is the belief of some stakeholders regarding both has sought to find out which is a better measure.

The comments are cited below:

Keith Duncan- President of the Private Sector Organisation of Jamaica (PSOJ)

“Inflation is the index that at the end of the day records movement in price levels and impacts purchasing power – and this is where we need to focus. Movement of the exchange rate will show up in the inflation numbers. As such, extreme volatility in the exchange rate which creates disorderly market conditions should be minimised.”

Dr Andre Haughton- Lecturer in Economics at the University of the West Indies (UWI)

“In a small island developing state that operates an open economy, the exchange rate is as important as inflation in determining the overall cost that is borne by the economic agents of a country. Whenever the exchange rate depreciates by a per cent, our national debt also increases by 0.5 of a per cent. Therefore the debt has an impact on 1. Government and 2. Businesses; as when they purchase goods from abroad or any type of equipment this has an impact on the overall expenditure and therefore when they use these goods to produce other goods they will be more expensive or even if they are buying goods to resell then these become more expensive also for the consumer.

So the exchange rate is an important factor in determining the overall cost burden on consumption, not just of household items, but for durables and input as well. More importantly it has an implication for the country's national debt.”

Richard Pandohie- President of the Jamaica Manufacturers and Exporters Association (JMEA)

“There has been a paradigm shift in Jamaica's monetary and fiscal policy, which has resulted in many positive results; low interest rates, low unemployment, low inflation, rising Net International Reserves (NIR) etc.

“As a result, we must give credit to the policy makers and the financial teams for sticking to their guns and creating this turnaround.

It is true that we have been accustomed to monitoring the exchange rate and have achieved very little from doing this. The idea of a controlled, reasonable inflation rate makes perfect sense, as it affects the purchasing power of everyone in the society.

“On average, most manufacturers import 85-90 per cent of their goods and services. Currently, the impact of the declining exchange rate is not being passed through in full to consumers, so the impact of the exchange rate on inflation is insignificant; however, companies are experiencing margin erosion as they strive to protect domestic sales.

“The idea behind a competitive exchange rate (led by devaluation in Jamaica's case) is to ensure that our domestic goods and services are competitive in the global economy. This, in theory, will stimulate more demand overseas, allow us to earn foreign exchange, invest in more production and hire more high-quality workers with higher disposable income.

“The issue that we are having is that we are not benefiting from the devaluation as we are not an export economy (except for tourism). The issue of growing our exports, especially value-added exports is a must-fix issue.

“Of course, the variables that are being measured are all related to the formal economy, which means more than 40 per cent of the economy is unaccounted for. Additionally, with a significant number of households being supported by remittances (our second-highest earner of foreign exchange), a devaluing currency is helping to increase the disposable income of many households.

“These are all factors that make Jamaica's economic analysis a complex scenario.

“There is no silver bullet and at the end, we will have to earn more and grow our economy.

“So, while inflation is key to impacting domestic demand and needs to be controlled at a reasonable level; the FX rate is key to impacting our international trade and both need to be balanced to drive consumption domestically and internationally to achieve sustainable economic growth.”

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