Last week the US Central Bank (Federal Reserve) cut its policy (federal funds) interest rate by 0.5 per cent or more than many expected. This was their first interest rate cut since they began raising rates in 2022, signalling clearly that they want to bring interest rates down fast from the 5.5 per cent peak.

Its forecasts suggested another minimum of 0.5 per cent in cuts before year end, with a probable target of around 3.5 per cent by the end of 2025, meaning another 1 per cent cut next year. The dovish Federal Reserve President Austan Goolsbee, at a post-Fed meeting event, suggested many more rate cuts of “hundreds” of basis points (one hundredths of a per cent) were appropriate as the federal funds rate was currently way above neutral.

The more aggressive Fed cut will come as a relief to the Bank of Jamaica (BOJ), which, since the end of June, has followed through on its commitment to ease what was an extremely tight liquidity situation, with a collapse in rates paid on its 30-day BOJ certificate of deposits from near 11 per cent to below 7 per cent. However, so far the BOJ has only cut their local “signalling” policy rate by one quarter point to 6.75 per cent, which is critical as the benchmark reference rate from which commercial banks mainly price their loans.

Unfortunately, economic weakness now looks widespread in Jamaica, including, critically, in business lending. To focus on just one industry, tourism, the issues include the lagged impact of the travel advisory, a 12 per cent reduction in seat capacity (driven by Boeing’s plane delivery problems), typical US election uncertainty delaying travel, and importantly, the exhaustion of US excess consumer pandemic savings, among others.

Just as there was a lag in lending rates going up, there is likely to be a long lag in lending rates going down without a very clear “credible” signal by the BOJ of a change in policy. It is worth remembering that the BOJ started roughly six months earlier than the Federal Reserve and increased rates by 6.5 per cent verses the Fed’s 5.25 per cent, with their first move being by 1 per cent. A target of a 3 per cent reduction in our signal interest rate, between now and end of next year, or even faster, may actually be reasonable in the current global and local environment. It is time to recognise that while the Bank of Jamaica does not have the dual mandate of the US Federal Reserve (meaning inflation and full employment have the same weight in interest rate decisions), it does have mandates beyond inflation, albeit not of the same weight.

Moreover, Jamaica’s policy rate is not the same as the federal funds market, which is a target rate of the Federal Reserve for US commercial banks to lend excess reserves held at the Fed to each other on an overnight basis which the Federal Reserve increases or reduces liquidity as necessary to achieve. Our interbank lending, to the degree that it even occurs, due to the oligopolistic nature of our banking system, will likely be at or near the penalty rate at which an institution would have to borrow directly from the central bank, currently still at 10 per cent or 3 per cent above the policy rate before the recent cut.

The BOJ has already, in line with a recent International Monetary Fund paper’s advice, signalled its intention to ignore the recent Hurricane Beryl-induced spike in inflation to 6.5 per cent, which it forecast would likely keep inflation out of its 4 per cent to 6 per cent range over the next three to five months. However, they also need to look at the holistic impact of the continuing regulatory and internationally driven capital tightening in our financial system when looking at the impact of its monetary policy, as tighter capital requirements and regulation effectively can mirror the impact of monetary tightening on the economy, particularly through its impact on already weak business lending.

Finally, a cautionary look back to a 2009 Jamaica Chamber of Commerce economic conference with Stanford Professor Donald Harris may be in order. Harris wrote a revised paper in 2010 on his presentation for the Jamaica Chamber of Commerce entitled “Jamaica’s Debt – Propelled Economy : A Failed Economic Strategy and Its Aftermath”.

His key quote from my Jamaica Observer article at the time was: “The key instrument, the Government’s weapon of choice for defending the exchange rate, is the interest rate…The supplementary weapon used to defend the exchange rate is the international reserves. Build up of massive reserves, through itself a source of excess demand in the foreign exchange market, is supposed to be a threat held by Government over the heads of agents in the market to enforce market discipline.”

While the situation now is quite different, with rough a current account balance (we spend what we earn internationally if we include remittances) rather than borrow to accumulate reserves, we still have to be very careful not to return to the bad old days of using tight money to target the nominal exchange rate at the expense of our international competitiveness.

We leave the last word today to Harris, who in a recent e-mail noted: “It is certainly important for the BOJ to deal urgently with needed adjustment in the level of interest rates in the light of existing conditions in the capital market in Jamaica and spillover effects from changes occurring now in other markets, the USA in particular. But I think it is equally important and urgent to deal with critical factors affecting access to credit and hampering the pass-through from interest rate changes to users of credit. Among the relevant factors, I would include the collateral problem, security of transactions, inefficiencies in the payments system, and weakness in the application and use of available technology to solve some of these problems. As regards technology, it seems that Jamaica is far behind what is being done already in other developing countries.”