Stop currency crisis talk!

Ja$ movements are as expected

Kevin O'Brien Chang

Tuesday, November 12, 2019

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When I came back to Jamaica from school in Canada in 1989, the Jamaican dollar was valued at $5.75:US$1. By 1994 it was over $33 — a 583 per cent increase in five years. It is now $141, meaning a 2,452 per cent increase over 30 years. Given this historical context, the five to 10 per cent fluctuations of recent years are hardly worth panicking about.

One basic component of Economics 101 is the Relative Purchasing Power Parity theory, which states that the real cost of a good should be the same in all countries. Hence, differences in national inflation rates will eventually be reflected in exchange rates, and countries with higher inflation will experience currency devaluation. So if Jamaica's inflation rate is 14 per cent, and the US's is three per cent, the Jamaican dollar should depreciate against the US dollar by 14 per cent less three per cent, equals 11 per cent, which actually has been roughly the average annual situation since 1989 — 11 per cent inflation differential and 11 per cent devaluation.

Purchasing Power Parity (PPP) does not always hold in the short run, but economic forces eventually equalise the purchasing power of currencies in the long run, a typical time horizon being four to 10 years. PPP has pretty accurately tracked the Jamaican to US dollar rate since the Jamaican dollar floated in 1989, as the included table and graph show. Indeed, the current predicted rate almost exactly matches the actual rate of 141.

(See http://www.kevinobrienchang.com/articles/valuing-the-j-by-ppp-and-big-mac-.html and http://www.jamaicaobserver.com/business-report/is-the-exchange-rate-on-target-or-is-it-a-whopper-the-jamaican-dollar-in-historical-perspective-1971-2018_139727#gallery_2)

All the above is surely well known to Bank of Jamaica head Richard Byles, Private Sector Organisation of Jamaica President Keith Duncan and Finance Minister Nigel Clarke. It's hard to understand why these learned gentlemen have not jointly educated the public on these PPP realities, instead of letting the media alarm the public with misleading headlines about a currency crisis.

Most disappointing of all is Opposition spokesman on finance Mark Golding ( http://www.loopjamaica.com/content/golding-lashes-govt-over-unstable-exchange-rate). He must know economic theory taught at Oxford is totally at odds with the irresponsible, politically motivated nonsense he is spouting, which risks undermining the Bank of Jamaica's targeted inflation policy. How can a country progress when those who know better do not do better?

All exchange rates fluctuate normally in a 10 per cent, or so, band. But barring some unforeseen inflation explosion, as Jamaica witnessed in 1990-1996, or a severe exogenous shock like oil prices soaring, the Jamaican dollar is unlikely to go up or down very much against its US dollar counterpart outside what PPP predicts, which right now is the $141 prevailing on the market.

We must presume the economic experts at the Bank of Jamaica and International Monetary Fund know why they consider inflation targeting of four per cent to six per cent the optimum strategy for Jamaica. But they also must know that given an expected US inflation of roughly two per cent, we can expect about a five per cent less two per cent, equals three per cent annual decline in the Jamaican dollar to US-dollar rate going forward. Considering the JA$:US$ rate has averaged a roughly 11 per cent annual decline since 1989. This should hardly be an unmanageable situation. Developing a forward foreign exchange market as the Private Sector Organisation of Jamaica is urging would certainly help. But it is high time that the Jamaican public was educated about the expected currency consequences of inflation targeting.

This country has enough real problems; having the world's second-highest murder rate being the main one. So we need to stop wasting time and energy on the imaginary issue of exchange rate volatility when our currency movements are, on the whole, very much in line with accepted economic theory. As long as we keep inflation under control, we have nothing to fear exchange rate-wise, but fear itself.

Kob.chang@fontanapharmacy.com


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