CHANGES in the real effective exchange rate (REER) in Jamaica have a negligible impact on economic growth, according to a research paper on the subject matter that was published by the Bank of Jamaica (BOJ) in December.

The research, a BOJ working paper entitled Real Exchange Rate and Economic Activity in Jamaica”, which was prepared by the central bank’s staff Alvin E Harris and Prudence Serju-Thomas, examined how deviations in the REER from its equilibrium affect Jamaica’s gross domestic product (GDP) (and its components) over the period 1998 to 2020.

The paper finds that for every one per cent appreciation of the REER, Jamaica’s GDP declined by as much as 0.02 per cent, with the decline coming after two and half years.

The authors state, “The decline in GDP is unambiguously reflected in decreases in real spending on imports and exports and, consequently, in a reduction in real net exports. This suggests that the real depreciation in the real effective exchange rate over the past 10 years has weakly supported economic activity and cannot be ruled out as a component of a strategy to support GDP growth.”

The paper also finds that tourism value-added increases in response to a loss in competitiveness.

REER is the real effective exchange rate — a measure of the value of a currency against a weighted average of several foreign currencies — divided by a price deflator or index of costs. An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.

The researchers state, “While the magnitude of [the] impact is small, it is broadly consistent with the findings from studies on other small open economies”, as evidenced in other research cited in their paper.

The main reasons for this, they argue, is that generally small impact are [due to] weak institutions and the level of a country’s development, which collectively tend to discourage the response of the private sector to relative price signals.”

They observe that the spending channel through which this shock largely works, appears to be net export spending, which declines by a maximum of 0.11 per cent by the second quarter following the shock.

“This response is influenced by real spending on exports of goods and services, which falls by a maximum of 0.15 per cent by the eighth quarter [two years],” according to the researchers.

“These results confirm a prior expectation that an appreciation makes exports uncompetitive, which incentivises a real reduction in demand from foreign countries,” the authors state.

In addition, in the face of real appreciation… differences are shown in net export spending, consumption spending, fuel imports, investment spending, gross exports of goods (BOP) and net export of goods (BOP).

For other components of spending, the results show that the real appreciation induces increases in real consumption spending and investment spending, albeit insufficient to offset the impact on overall GDP from the decline in net export spending.

Tourism

The results show that, in response to the appreciation of the real exchange rate, the tourism industry grows. Researchers state, “This strongly suggests that the industry is resilient in face of the higher cost.”

They add that the finding may be attributed to greater than normal promotional activities by industry players and the Jamaica Tourist Board during periods of strain, which are geared towards attracting additional visitors to the islands which are not captured directly in the model.

They state, “The main finding of the paper is that real depreciation has a positive impact on Jamaica’s real GDP, but the effect is small. This suggests that the real depreciation over the past 10 years has weakly supported economic activity [but] cannot be ruled out as a part of a strategy to support GDP growth in the medium term.

The authors suggested that, “along with maintaining relative price competitiveness, attention to the structural impediments to growth [including access to educational opportunities and crime] will help to deliver faster growth.”