The father of modern macroeconomics, the celebrated John Maynard Keynes once said, “The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method, rather than a doctrine, an apparatus of the mind, a technique which helps its possessor to draw correct conclusions.”

Keynes words are especially relevant to monetary policy. In recent times it is not uncommon for some economists to regurgitate the received wisdom of what to do during a period of inflation. The story goes something like this: “Where inflation is running above target the central bank should increase the policy interest rate, this will cause other interest rates in the economy to rise. With higher interest rates firms will put off plans for expanding their firms and might even reduce their current size. Consumers will put off plans to purchase houses, cars, furniture, and other household items; they might even reduce food consumption. With a fall in the demand for goods and services, prices should fall. In the absence of interest rate increases, the concern is that inflation will become entrenched resulting in an inflationary spiral; think about a scenario where firms charge higher prices, workers demand higher wages to pay for the now more expensive goods, firms require even higher prices to pay for costlier inputs and their more expensive workers, workers demand even higher wages, and so on and so forth — inflation spirals out of control.”

The above story ‘approximates’ better to economies which are large, relatively self-sufficient, and the financial sector is sophisticated. The US is one such economy. It is important to note, too, that whenever the US economy dips into a recession as result of interest rate increases, pushing up the level of unemployment, the US Government can support its citizens through unemployment benefits and other transfer payments. These transfer payments can be funded through borrowing by the US Government; invariably, said borrowing is done in US dollars, and we know who prints those.

Jamaica, a small island developing State, highly open to international trade and, by extension, external shocks, does not have the luxury of borrowing so easily, nor the fiscal space to adequately support its citizens in the event of a domestic downturn. What is more concerning, in the context of Jamaica, is what macroeconomists call the transmission mechanism. Put simply, what is the process through which monetary policy (interest rate hikes) affects the economy — output and prices?

Will the story I have told above work in the case of Jamaica? Higher interest rates will further decrease demand for goods and services, but will such a result lead to lower prices? Higher interest rates are also likely to reduce domestic levels of investment, and some medium, small and micro enterprises (MSMEs) might decide to temporarily, or permanently, close their operations. With reduced output, and reduced domestic competition, notwithstanding reduced demand, will Jamaican firms lower their prices thereby sending inflation back to the 4 per cent to 6 per cent range?

As a result of increased prices consumers are already cutting back on the demand for goods and services, reducing concerns about what the Bank of Jamaica (BOJ) calls second-round demand effects. And with reduced demand for goods and services for the better part of a year, are prices falling? Are food prices falling?

Readers should note that a slowing in the growth of prices should not be confused with price decreases; it simply means that prices are still rising but at slower rates. Inflation remains elevated primarily due to external factors. As an example of the inflationary devastation of Joe Biden and Putin’s war in the Ukraine a bushel of wheat rose from US$787 on February 21 (a few days before the invasion) to a high of US$1,283 (May 17).

To be clear, I have consistently maintained that the BOJ had to unwind the accommodative (expansionary) monetary policy it had in place for years. For example, the policy rate was reduced to 0.5 per cent in August 2019 and kept at that level until September 2021 encouraging greater spending and investment. In my view, moving towards perhaps 4 per cent should have sufficed; this rate is the International Monetary Fund’s (IMF) “neutral rate” — neither accommodative nor restrictive — for Jamaica.

Lest I be misinterpreted, I am not suggesting that the IMF is against the BOJ’s interest rate hikes. Aside from rate hikes the BOJ must be commended for lowering exchange rate volatility and allowing the dollar to appreciate in a period when the currencies of about 90 developing countries have weakened against the US dollar in 2022; the loss in value was greater than 10 per cent for more than 30 developing countries.

Governor Richard Byles, in his recent pronouncements on BOJ policy, spent lots of time talking about the exchange rate. I have no issue with that. In fact, in my February 14, 2022, Jamaica Observer column, ‘How about a stable, predictable exchange rate?’, I argued for the exchange rate to be a secondary target, even if there is no explicit target attached to it. While in a de jure sense the BOJ has a singular mandate — inflation targeting — there is now greater exchange rate management (de facto secondary target), with the BOJ pumping more than half a billion US dollars into the economy already for 2022, while ensuring that the reserve of US dollars remains comfortably above required levels.

In my next article I will address the exchange rate more comprehensively.

The recently published UN Conference on Trade and Development (UNCTAD) report, Trade and Development Report 2022, notes that, “With inflation already beginning to ease in advanced economies, UNCTAD calls for a course correction in favour of policy measures targeting price spikes in energy, food, and other vital areas directly… UNCTAD urges a more pragmatic strategy that deploys strategic price controls, windfall taxes, anti-trust measures, and tighter regulations on commodity speculation.”

What UNCTAD is arguing is that, instead of blunt tools, such as policy rate increases, more direct measures are needed to arrest inflation. Admittedly, price controls come with their own problems, but temporary controls in specific areas should not be ruled out. More direct transfers of cash to the most vulnerable should be considered. The Development Bank of Jamaica (DBJ) provides MSMEs with cheaper loans, but there is always room for facilitating greater take-up by firms.

The inflation rate is expected to return to the BOJ’s target range towards the end of 2023. Some might shout that aggressive policy rate changes today are the cause; others might shout, not because A comes before B necessarily means that A caused B.

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.