BOJ: Output lower than Jamaica's economic capacity
As the Bank of Jamaica, BOJ, monitors credit conditions in contemplation of further cuts to the policy rate if required, a key theme of the central bank's authorities is how much slack remains in the economy.
On Tuesday, the BOJ decided to hold the policy rate the interest rate offered on overnight placements with the central bank unchanged at two per cent.
The policy decision reflects the central bank's updated assessment that inflation, currently below target, will rise towards the lower end of the earmarked 4.0 per cent to 6.0 per cent by the March 2019 quarter and will approach the middle of the target range thereafter, according to BOJ Governor Brian Wynter.
"The path for inflation continues to reflect some slack in the economy, however, which underscores the continued elevated risk of inflation falling below the baseline projection," said Wynter at the bank's quarterly press briefing in downtown Kingston on Wednesday.
The amount of slack in the economy is essentially a measure of the quantity of unemployed resources. It represents the quantity of labour and capital that could be employed productively, but instead remains idle. More formally, it is defined as the difference between the economy's productive capacity the amount of goods and services that could be produced if all labour and capital were fully and efficiently employed and the actual level of economic output.
Wynter noted that in May, he signalled the possible need for more aggressive monetary policy easing, given the central bank's concerns about low core inflation in the context of lower-than-potential gross domestic product growth rates.
That was followed in June by a reduction of 50 basis points in the policy rate. The decision to maintain it at two per
cent followed cumulative downward adjustment of 100 basis points since the start of the year and was made in the context of signs that have emerged of a pick-up in the rate of expansion of private-sector credit, Wynter said.
Credit extended by deposit-taking institution to private-sector businesses and individuals grew at an annual rate of 15.9 per cent at June 2018, compared with 13.9 per cent at March 2018 and 12.4 per cent at June 2017.
Wynter said that the expansion was evenly balanced between business loans, which grew 15.8 per cent, and personal loans, up 16 per cent. Simultaneously, the bank has seen weighted average rates at commercial banks continuing their decline during the June 2018 quarter.
"If this acceleration in private-sector growth continues, the resulting increase in economic activity is going to support inflation returning to the target of 4.0 per cent to 6.0 per cent with greater certainty than we see today," the governor said.
However, the BOJ "will closely monitor these credit conditions and will make further cuts to the policy rate if they are required," he added.
The BOJ has assessed that the main upside risks to the inflation forecast include weather conditions being worse than anticipated, domestic demand conditions being higher than projected, and the exchange rate depreciating faster than expected.
The risks from international commodity prices, particularly crude oil, are skewed to the downside.
"Importantly, there is this risk to the downside of inflation arising from the persistence of slack in the economy and that risk remains, in our view, elevated," said Wynter.
The governor also used the opportunity to address what he said was a narrative circulating in the public domain that the BOJ was manipulating the exchange rate in an effort to influence an increase in inflation to the target range.
"There is absolutely no truth to this narrative. It would be to do the exact opposite of the explicitly stated objective of the B-FXITT mechanism that was introduced in July 2017," said Wynter, referring to the Bank of Jamaica Foreign Exchange and Intervention Trading Tool.
It would also violate the "well-established commitment of the Government to a flexible, market-determined exchange rate," he added. "We have not been doing that, we are not now doing that, and we will not do that," the governor declared.
Increase economic activity
Wynter said the channel through which the central bank expects inflation to rise to the target is through an increase in economic activity.
"Based on our assessment, there is still some slack in the economy, as actual output remains lower than the bank's estimate of the economy's capacity or, in other words, its potential for growth at the moment and in this forecast horizon. That's what I mean by slack in the economy," he explained.
"While we are now seeing some encouraging signs of the faster expansion in private- sector credit that we need, we need to be sure that it is sustained so that the slack is removed as quickly as possible."
Noting that the BOJ neither focus on nor seek to defend a particular exchange rate, but instead, seeks to ensure the orderly functioning of the market, Wynter said that in accordance with the B-FXITT rules, it sold US$65 million over the last two weeks.
In addition, the BOJ has committed to sell a further US$46.5 million over the next four weeks.
Other actions by the central bank included a flash sale last Friday that was aimed at averting disorderly market conditions that the BOJ judged to be imminent.