It’s the exchange rate, BOJ!
On July 5, 2022, Bank of Jamaica (BOJ) Governor Richard Byles, accompanied by deputy governors Wayne Robinson and Robert Stennett, addressed a sitting of the Standing Finance Committee (SFC) of the House of Representatives. The central issue on the agenda was the BOJ’s recent monetary policy decisions.
The governor is having some difficulty justifying the seven consecutive interest rate increases decided on by the BOJ’s Monetary Policy Committee (MPC), which he chairs. The BOJ’s de jure policy regime is based on a single nominal anchor: the inflation rate. However, it is the exchange rate which seems to be currently keeping policymakers awake, especially as US financial assets become more attractive and domestic inflation is primarily driven by external factors as opposed to domestic demand. In my view, what appears to be a policy inconsistency is causing consternation among stakeholders.
When asked by the Minister of Finance Dr Nigel Clark what he (Mr Byles) would say to Jamaicans who are worried about rising mortgage costs etc, the first words out of the mouth of the governor were, “It is really a trade-off between interest rates and the exchange rate.” Simply put, it is either higher interest rates or a higher exchange rate, and a higher exchange rate will fuel higher inflation.
Some might argue that, ultimately, the war is against high inflation, so why split hairs over how it gets done. Well, how it gets done is important as different policy measures could be taken depending on where the BOJ decides to focus its energies. If policymakers are more concerned about the exchange rate, it can be controlled through means other than interest rate changes. To its credit, the BOJ has also been using other monetary policy measures, but changes in the policy rate take centre stage and is prominently displayed on the BOJ’s website.
Governor Byles was quick to point out, or boast, that it is easier to access foreign currency in Jamaica than in Barbados. This is true; however, in February of this year, the BOJ, through the Financial Services Commission (FSC), placed a six-month moratorium on the issuance of foreign exchange instruments. This was a clear move to curtail the outflow of capital and to reduce the speculative demand for US dollars. After push back from the Jamaica Securities Dealers Association, the moratorium was relaxed, but dealers are required to show how their actions would not create undue demand for foreign currency. At the same time, the foreign currency interventions of the BOJ explicitly require that the foreign currency it sells to foreign currency dealers are to be resold to firms for the purchase of essential items such as fuel and food. There are also restrictions on the price at which foreign currency dealers can resell the foreign currency they purchase from the BOJ.
There is another consideration which, as far as I am aware, has not been discussed. In September 2017, years before the novel coronavirus pandemic and war in the Ukraine, the inflation target range of 4-6 per cent was set by the Minister of Finance in consultation with the BOJ. The inflation target is a medium-term target. According to the Bank of Jamaica Amendment Act (2020) – Part VAA, 34FA – “Medium term means, in relation to the establishment of an inflation target, a period of not less than 36 months” This means that the inflation target should be established for a period of at least three years. Certainly, a credible inflation targeting regime cannot operate in a framework where the bullseye can be easily moved.
Yes, contrary to what some might think, the inflation target is not set in stone. September 2020 would have made 36 months since the setting of the first inflation target and so at any point after that the target could have been adjusted. It stands to reason that, if in “normal” times a rate of 4-6 per cent was set, then surely in these difficult times the range could have been adjusted upwards. However, the minister of finance is likely to say that the target is a medium-term one and, as such, it can remain put as current external inflationary conditions are likely to unwind within three years (September 2020 to September 2023), or so we hope. Of course, the other side of the argument is, if we expect such external conditions to unwind in the medium term, then perhaps the policy rate need not be heading towards 7.5 per cent and beyond.
Here is what Sarwat Jahan wrote in his article ‘Inflation targeting: Holding the line’ in the International Monetary Fund’s finance and development publication: “Rather than focusing on achieving the target at all times, the approach has emphasised achieving the target over the medium term — typically over a two- to three-year horizon. This allows policy to address other objectives — such as smoothing output — over the short term. Thus, inflation targeting provides a rule-like framework within which the central bank has the discretion to react to shocks. Because of inflation targeting’s medium-term focus, policymakers need not feel compelled to do whatever it takes to meet targets on a period-by-period basis.”
Further, the fine-tuning approach taken by the MPC, as cautious as it seems, disrupts the decision-making processes of banks, firms, and people. Unlike Ms Daisy, your favourite soup lady, who writes the price for her excellent soup on a piece of disposable cardboard, commercial banks cannot and do not change their interest rates that easily, it takes time for their systems to be adjusted. Of course, changes in the policy rate can quickly affect commercial bank behaviour by increasing the opportunity cost of liquidity. In sum, regardless of all the data that the MPC examines at every meeting, I fail to see how it can justify fine-tuning. To be sure, Jamaica does not have the wide, deep, and sensitive financial system as obtains in larger economies; economies in which any whisper of a rate change by a central banker over a cocktail can cause the markets to move.
A BOJ survey notes that 62 per cent of domestic firms surveyed are unaware of the inflation target and 77 per cent were not aware of the point-to-point inflation rate. The minister of finance was seemingly shocked by the lack of awareness. I am willing to bet, however, that domestic firms do understand that their margins are shrinking and so every dollar they can squeeze out of the consumer they will. With each day that commercial banks put off interest rate increases while seeking to make sense of the BOJ’s rate increases, firms will be pushed to overcompensate on the increases they add to their prices.
Curiously, there has been no serious discussion, or questions, about the impact of interest rate increases on the housing and construction sector. This sector remained a bright spark during the height of the pandemic. There is the very real possibility that there is a bubble in the housing market as the fundamentals of the domestic economic situation (for example, household income) do not seem to support the rapid price increases, notwithstanding, of course, the fact that the stock of housing is insufficient.
Yes, Jamaicans in the Diaspora buy properties here and support relatives seeking to purchase properties, the question is: Will they continue to do so given that they, too, are now facing troubling and uncertain times? Global supply chain disruptions continue to push up the cost of raw materials, including building materials. Taking all of these into consideration, will we see a bursting, or slow deflation, of what appears to be a bubble?
The BOJ is experiencing the first real test of its inflation targeting regime. It is a delayed baptism of fire.
Dr Samuel Braithwaite is a lecturer in the Department of Economics at The University of the West Indies, Mona. Send comments to the Jamaica Observer or braithwaitesamuel@gmail.com.