An edited version of Finance Minister Dr Nigel Clarke’s special policy address on the Bank of Jamaica modernisation programme yesterday.

She was a professional who started at the bottom. Didn’t have a car for many years, took two buses to get to work, on time, I might add, put in a solid day’s work to head home.

Balancing work with children was tough, not to mention affording school fees and books. But she worked hard and progressed at the ministry, retiring in a senior administrative position. Her boss had a wonderful send off for her. She had made it.

Her problem, however, was that she retired in March 1993. Inflation in those days was sky high, 40% per annum. By March 1998, ie within 5 years, her pension was worth one-third of its value; and by March 2003, ie within 10 years, it was less than one-fifth of its original value. She died in 2007, dead broke.

There are many such stories. Nurses, police officers, teachers, ancillary staff, janitors, and even parliamentarians and former ministers.

The story would be similar, but less pronounced for those retiring in 2005. By 2010 pensions would be worth half of their value instead of one-third.

I see the files every day at the Ministry of Finance, where there are many, persons applying for compassionate consideration because, though they did their part, worked hard and played by the rules, elevated historical inflation of yesterday defeated them.

Those, however, are just the ones who are visible to formal society. There is the larger category of the permanently seasonally employed, unemployed and under-employed for whom inflation in Jamaica has dealt a harsh hand.

High, pervasive inflation has ruined tens, maybe hundreds of thousands of lives in Jamaica and the primary and second order effects of high inflation have devastated thousands of businesses.

We have lived it. We know it. High inflation is synonymous with instability; it works against investment, it is not conducive to long-term thinking, it retards or reverses development, leads to dysfunctional behaviour, and impoverishes people. High inflation is the enemy of the poor, those without assets and those on fixed incomes.

Meanwhile, those with large pools of unleveraged real assets are largely insulated from high inflation. So, in that sense, high inflation sows the seeds of inequity and breeds social injustice.

Today, I will be speaking about institutional reforms that the Government of Jamaica will embark upon, designed to ensure that Jamaica remains on a path of low, stable and predictable inflation for the foreseeable future.

What is inflation?

We know it when we experience it, but how do we define it? How do we measure it?

Thirty years ago, Jamaica, through the Statistical Institute of Jamaica (STATIN), started the Consumer Price Index (CPI) that measures the movement in consumer prices experienced by Jamaicans.

The CPI is obtained by comparing, through time, the cost of a fixed basket of goods and services purchased by Jamaican consumers. This basket consists of approximately 300 items in the categories of food & drink, fuels, household supplies, rent and housing, household furnishing, healthcare, personal clothing, and transportation and is fairly detailed.

Within food and drink, for example, STATIN captures price data on dairy, oils & fats, vegetables, fruits, a range of beverage types, meat, fish as well as meals away from home, and food and drink have a weight in the basket. Similarly they capture rental and other housing costs.

The price of this representative basket is then compared over time and changes in its value represent what we describe as inflation.

Every month STATIN officers go to scores of providers of these goods and services across the length and breadth of Jamaica to obtain prices of this large representative basket to compute the movement in the CPI for that month.

STATIN calculates Consumer Price Indices for all of Jamaica, which is what we usually refer to, but they also calculate CPI separately for:

• the Kingston Metropolitan Area which covers Kingston, urban St Andrew, Portmore and Spanish Town,

• Other major towns which include the main towns Savanna-la-Mar, Lucea, Port Antonio, and Falmouth, etc

• rural areas

That way we have detailed information about how a very wide range of prices are moving across Jamaica on a whole, by region, and across the urban rural divide and this is available to the media and to the public.

The movement in these prices gives us our inflation rate which we can measure from month to month, from calendar year to calendar year, or from fiscal year to fiscal year.

STATIN has this data for 30 years and measure in the same way as when inflation was 80% in 1992 and 40% in 1993 as they do today when 12 month inflation to June 30, 2018 was 2.8%.

I was in Parliament on Tuesday and the Leader of Opposition Business made a contribution where he inadvertently made the erroneous leap from a comment about fuel prices to wrongly conclude that inflation was “sky-rocketing”.

I was compelled to rise on a point of order to point out that he may be correct about fuel, but it represented but one important component in the basket of the average Jamaican, and other prices, that take up a sizeable chunk of one’s income such as rents, were not moving in the same way for the period under consideration and as a result 12 month inflation was 2.8%, quite the opposite of his claim. He graciously accepted my point.

So the goal of policy should be to keep prices stable and we measure price stability or instability through tracking of the CPI changes which give us inflation. So whose job is it to ensure price stability?

Well, firstly, monetary policy is what is used to influence the level of inflation in an economy. And by monetary policy we mean movements in the level of interest rates as well as the levels of money supply or the total money in circulation in an economy, both of which are in the purview of the Central Bank.

So if we want to maintain low and stable inflation we have to make sure that that the governance and institutional foundations of our central bank are suited to the purpose.

ECONOMIC INDEPENDENCE

In previous speeches, I explained that the priorities for the Ministry of Finance and the Public Service at this stage of Jamaica’s development are the pursuit of economic independence, the expansion of economic opportunity for all and the protection of the vulnerable.

Economic independence means transitioning from our history of chronic indebtedness, low growth and reliance on bailouts from international partners, to a sustainable path of economic performance backed by sound legislation and institutions. In short, we must take full and competent responsibility for our economic fortunes and give a better start to future generations of Jamaicans.

Achieving this objective of economic independence requires the development of strong public sector institutions, long-term thinking and consensus-building processes. That will allow us to pursue policies with greater flexibility, and having an increased ability to address priority areas as determined by Jamaicans and achieve these objectives without compromising that very independence.

A few weeks ago, I announced that Cabinet had approved one of the key pillars of the vision of economic independence, the establishment in Jamaica of an independent fiscal institution. This institution is envisioned to give legislative and institutional permanence to the principles of:

1. Enhancing accountability of the fiscal policy-making process;

2. Deepening transparency of Government finances;

3. Strengthening the credibility of Jamaica’s fiscal path;

4. Promoting inclusiveness in the policy discussion space; and

5. Taking greater societal ownership of Jamaica’s economic direction.

The design of the institutional framework that we can rely on to deliver macroeconomic stability consistently well into the future requires a second pillar, however.

I am pleased to advise that work to erect the second key pillar of Jamaica’s economic independence has been put into motion. A few weeks ago, Cabinet gave its approval to detailed proposals for the modernisation of the Central Bank through amendment of governing legislation.

The proposals would amend the Bank of Jamaica Act, the Banking Services Act and the Public Bodies Management and Administration Act and enable the issuance of new governance regulations for the Bank of Jamaica. These legislative changes would follow changes in recent years in keeping with international best practices.

In 2014, the Bank of Jamaica (BOJ) was made autonomous with respect to banking supervision with passage of the Banking Services Act, and in 2015 the bank’s mandate was expanded to include responsibility for the maintenance of overall financial system stability.

REVISING CENTRAL BANK MANDATE

The reforms to be tabled in 2018 include a revision of the BOJ’s mandate. This involves establishment of a clear and prioritised mandate of price stability as the goal of monetary policy. Today, the mandate of the bank consists of multiple goals, which are sometimes in conflict. As a result, market participants and investors suffer from a lack of clarity around the BOJ’s intent and actions. This has a cost.

Going forward, the principal monetary policy goal of the central bank will be to achieve an inflation target and all other tools and indicators will be subordinated to this aim.

The lenses through which the BOJ will view other variables is the lenses of the impact on inflation. By institutional design, therefore, Jamaican monetary authorities will pursue low, stable and predictable inflation as the exclusive monetary policy goal.

INDEPENDENCE OF THE CENTRAL BANK

Monetary policy decisions today may be expected to impact inflation outcomes in 12 to 18 months and possibly even 24 months and so monetary policy practitioners need to have a long-term perspective. For this reason, monetary policy is always forward-looking, and the policy interest rate setting is based on the BOJ’s judgement of where inflation is likely to be in the future, not on what it is today.

Politicians, however, are notorious for our short-term perspective, for good reason. So there is natural tension. If monetary policy is subject to political influence, monetary authorities can be pressured into pursuing expansionary policies for the short-term impact of this, which may be electorally convenient, while having disastrous longer term consequences on price stability.

A central bank under the control or influence of the political directorate can be pressured to sell and squander precious, hard earned reserves to artificially fix the level of the currency in response to anxiety, even if this undermines inflation objectives and even if such interventions have no real lasting effect, simply because it may be politically advantageous for the politician or the administration for that to happen.

A central bank under the control or influence of the political directorate can also be pressured into helping finance the Government, relieving it from the consequences of bad fiscal choices and policy, while imposing significant adverse consequences on the country over the medium term.

These concerns, in the Jamaican context, are far from theoretical. Jamaica is emerging from a long period of fiscal dominance from the early 1990s up until the last five years where, for much of the period arguably, monetary policy essentially propped up government finances.

While not explicit, the path of interest rates had less to do with inflation objectives and more to do with ensuring that the Government of the day could finance itself. It is for this reason that the focus of this thrust of reform is to strengthen the BOJ’s independence in order to ensure that there can be no undue political influence on monetary policy decision-making, and given the long lead time for monetary policy to take effect, independence allows for the preservation of monetary policy continuity across political cycles.

Under the planned reform therefore, the minister of finance will no longer have the ability to give directions on monetary policy. Having removed the ability of the minister to give directions on matters to do with banking supervision in 2015, this move to give the BOJ monetary policy independence means that we will be making the bank operationally independent.

As a single measure, this package represents one of the most consequential reforms of the last five years. A few other features designed to strengthen independence include measures to ensure that the tenure of board members is long enough to provide for individual independence and the development of sufficient experience and capability to discharge the functions of accountability successfully.

It will also be constructed that appointments are staggered so that while board vacancies are certain to arise during the course of each political administration, no single administration, ie, in a single term, can change the entire board.

All of this is with the aim of allowing the BOJ the operational space and independence required to pursue the monetary policy objective of low, stable and predictable inflation and delinking it from political pressures in this process.

CENTRAL BANK ACCOUNTABILITY

Now, I am learning that politicians are accustomed to being blamed for everything, even things they genuinely have nothing to do with. As a result, central bank independence can be legitimately concerning for politicians, unless it is accompanied by systems of accountability that make it clear where responsibility for the conduct of monetary policy lies.

For more serious reasons, however, such as democratic legitimacy, an independent central bank must be accountable to the public for its actions. As a result, an important feature of the reform will be to ensure that strong systems of accountability for the bank exist.

The reform will therefore require the BOJ governor to submit to Parliament and publish, at least every six months or more if directed by Parliament, or as determined by the governor, policy statements on the BOJ’s performance with respect to monetary policy, its achievements in relation to the inflation target and a monetary policy update.

In addition, the governor will be required to appear before Parliament at scheduled intervals to present monetary policy updates and to answer questions.

The bank’s governance structure will be enhanced with the clear demarcation and assignment of roles and responsibilities for policy decision-making, proper internal oversight and day-to-day management. Decision-making will be collective in nature, with external participation, rather than concentrated in an individual, allowing a range of input; new statutory committees will be established and existing ones will be strengthened.

Specifically:

a. The Monetary Policy Committee (MPC) will include outside members to bring broader perspectives to bear on monetary policy decisions;

b. Decisions of the Monetary Policy Committee will be accompanied by a concurrent explanatory note followed by disclosure of the minutes of Monetary Policy Committee meetings on a lagged basis. In this way, investors, consumers and businesses will have insight into the thinking of MPC members and what motivates their decisions. This transparency and enhanced accountability should allow for a greater understanding of monetary policy action, and it should facilitate more informed economic and investment decision-making while reducing risk premia.

c. Other committees.

BALANCE SHEET STRENGTHENING

The reforms will also strengthen BOJ’s balance sheet and ensure the maintenance of policy solvency going forward. This means that the bank will have the financial muscle to achieve its policy objective.

PRE-REQUISITES

Full-fledged inflation targeting regimes are being used by an increasing number of countries, including developing countries, to achieve and maintain low inflation. With changes to relevant Federal Reserve legislation in the US Congress in the 1970s that increased monetary policy independence, and the subsequent taming inflation that followed, the policy of central bank independence gained in credibility.

New Zealand in 1989, the UK in 1997, the European Union in 1998, similarly made their central banks’ independent, as have Canada and Australia and many developing countries such as Colombia, Mexico, Ghana, Uganda and to varying degrees Kenya and Tanzania and many more. Small countries like Iceland too. And the link between central bank independence, inflation targeting and low inflation has been firmly established.

The characteristics of these types of regime include increased transparency and accountability, the singular commitment of the central bank to the achievement of a time-bound, publicly announced inflation target and policy actions that are based on a comprehensive set of inflation data, including the inflation forecast.

We believe that this is the most effective monetary policy framework to deliver our objective of low, stable and predictable inflation. In this context, the modernisation of the Bank of Jamaica will see the institutionalisation of this inflation-focused monetary policy regime, which should inspire market confidence and facilitate a strengthening of financial markets while fostering sustainable growth and job creation.

There is general consensus that certain key conditions should be in place in order for a country to adopt an effective inflation targeting policy framework. These include:

• the formal and explicit adoption of an inflation target as the primary goal of the central bank,

• the absence of fiscal dominance,

• central bank independence,

• a flexible exchange rate regime,

• sufficiently developed financial markets,

• a stable financial system, and

• a central bank with the capacity to formulate and implement monetary policy with an effective and transparent communication structure.

Jamaica has made significant advances in a number of these areas. In preparation for this transition, the BOJ has already taken steps to enhance its ability to improve its monitoring, forecasting, data collection and policy analysis systems to enhance its ability to make consistent projections of the macro economy and to frame sound monetary policy advice.

Other initiatives being pursued include:

• improving the monetary policy implementation and transmission process

• developing the money market

• strengthening the bank’s capacity to ensure that it has adequate resources at all times

• enhancing the communication and public education

strategy, and

• assessing the parameters of the inflation targeting regime to ensure that a sufficient degree of fiscal and external stability has been established and the operational components are in place.

As I said above, a flexible exchange rate is a pre-requisite of a country’s ability to have an effective inflation-fighting regime. Jamaica has had a flexible exchange rate for several years and the mechanics of this have been strengthened over time.

Jamaica’s flexible or floating exchange rate allows us to pursue an independent monetary policy that is best suited to our economic circumstances at a point in time and is focused on achieving our inflation target.

For example, it is because we have a flexible exchange rate, and therefore an independent monetary policy, that the BOJ could reduce the policy interest rate eight times since October 2016 in response to our realities, even while the monetary authorities in the United States have increased the US policy interest rate seven times over the same period.

Without an independent monetary policy underpinned by a flexible exchange rate our monetary authorities would have been constrained to increasing interest rates even while domestic demand remains fragile. The BOJ has been implementing many reforms towards a credible inflation targeting framework including the introduction of competitive, market-based multiple-price auctions to buy and sell FX, which reduces the bank’s footprint in the FX market and improves market information and price discovery.

Plans are also being pursued to promote the widest availability of hedging products for buyers and sellers in the FX market.

EXTERNAL SUSTAINABILITY AND ECONOMIC INDEPENDENCE

The BOJ also has responsibility for the management of Jamaica’s foreign exchange reserves. The size of our reserves in relation to the value of our imports determines whether we are able to sustain ourselves without external assistance. That is, it determines our prospects for economic independence.

In 2013, Jamaica found itself in a position where we could not sustain ourselves and finance our imports without the financial assistance of the IMF. For Jamaica to be able to sustain itself in the future, without the financial support of the IMF, it will need to have sufficient reserves to protect us in the event of a rainy day.

Sufficient reserves are indispensable, for example, if oil prices rise significantly. If Jamaica does not have a sufficient buffer in those circumstances we will be unable to sustain ourselves without external assistance. If there is a natural disaster and domestic production comes to a halt and we have to import every single thing, without sufficient reserves our ability to sustain ourselves without external assistance, ie our economic independence would be compromised.

If there is a deep recession in the United States that causes tourism receipts and remittance flows to tank, cutting down foreign exchange earnings, without sufficient reserves our ability to sustain ourselves without external assistance, ie our economic independence, would be compromised.

The buffer of adequate reserves makes sure Jamaica remains externally sustainable and can finance itself in all circumstances without external assistance. This reform of operational independence of the BOJ keeps the hand of the politician away from the possible misuse of reserves, to stabilise for short-term political gain.

Time and time again countries have gone to the IMF because their reserves have reached dangerously low levels. Jamaica knows this well. Economic independence is advanced by decoupling the implementation and management of monetary policy from the political directorate and that is the aim of this reform.

We expect to table the legislation to give effect to the modernisation in October and to take it through the parliamentary process thereafter.