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Letter of the Day: Price data not reliable for currency valuation

Published:Friday | August 14, 2015 | 8:00 AM

 

THE EDITOR, Sir:

The International Monetary Fund representative in Jamaica has suggested that the currency is still overvalued and that further devaluation will be required to ensure that it is externally competitive.

Any devaluation of the currency should be based on changes to the real exchange rate. These show the relationship between Jamaica's inflation rate and the inflation rates of its main trading partners.

If Jamaica's inflation rate is rising faster than those of its main trading partners, the currency should be devalued to reflect this differential (the real exchange rate), in order to maintain its external competitiveness.

The current increase of the real exchange rate stems, however, from a decline in the inflation rates of the main trading partners and not from a marked increase of Jamaica's inflation rate. This has been caused mainly by the sharp fall in international oil (and gasolene) prices.

The fall in gasolene prices has had the effect of considerably slowing down the pace of consumer price inflation among the main trading partners, but it has not had a similar effect in Jamaica, because gasolene prices are not included in the country's index of consumer prices.

This anomaly is the result of the way in which inflation is measured in Jamaica. The consumer price index is based on surveys of the expenditure pattern of working-class households with relatively low levels of income. The index includes the majority of income earners but, because of their low incomes, it does not account for a high proportion of the economy's personal consumption expenditures, such as the purchase of gasolene.

 

revision of index needed

 

It is, in reality, an index of the cost of living of working-class households and not an indicator of overall consumer price inflation. This limits the extent to which comparisons can be made between Jamaica's inflation rate and those of its main trading partners.

The base of the present price index was formed about 10 years ago from a household expenditure survey that was done at that time. There is now a clear need to establish a new base to reflect the current pattern of such expenditure. But there has been no revision of the index, nor an update of its base, so it is likely that there are significant margins of error in its current estimates of inflation.

These factors outlined above indicate that the existing price data do not provide a reliable basis for evaluating the current status of the currency.

Exchange-rate policy should, therefore, focus on maintaining the stability of the exchange rate until conditions are favourable for pegging the currency to the US dollar.

E.A. SHAW

Economist