Briefing | The Jamaican exchange rate conundrum
How valuable was our currency?
Upon receiving Independence from Britain, Jamaica strengthened its currency board system by establishing the Bank of Jamaica. The exchange rate was pegged one to one with the British pound. Annual inflation rate was low and industrial expansion, including a boom in the bauxite industry, encouraged production towards the end of the '60s.
Operating in a fragile domestic political economy, Jamaica increased its imports relative to exports in 1972, increasing its current account deficit to US$48 million or three per cent of GDP. In 1973, the inflation rate increased by more than 30 per cent and the Jamaican exchange rate peg was switched from the British pound to the US dollar, since the US became Jamaica's major trading partner.
At the time, the Jamaican dollar valued more than the US dollar; trading at J$0.909 to US$1. The peg remained throughout the '70s, maintaining the Jamaican dollar at a higher value than the US dollar. The stronger Jamaican dollar was associated with increased demand imports, increasing the demand for
foreign currency. Consequently, Jamaica fulfilled its foreign
currency demand with borrowed reserves. A new policy
framework was imminent.
How were we affected by the first oil price shock?
In 1973, the domestic inflation rate hiked to more than 30 per cent, impacted negatively by the first global oil price shock. After falling to about 10 per cent in 1976, the inflation rate increased significantly; more than 25 per cent by 1978 as a result of the second oil price shock. If the country's demand for foreign currency remained the same, without exchange rate intervention, the country's foreign currency reserves would have been quickly depleted. In an effort to combat the pressure on domestic holdings of foreign currency, Jamaica exercised a dual exchange rate system between 1977 and 1983. A basic rate of J$0.909 to US$1 was used for essential imports, government foreign spending and the bauxite sector, while another rate of J$1.25 to US$1 was applied to all other transactions.
Quantitative restriction on imports was the preferred method to constrain depletion of the borrowed reserves. From this strategy, the inflation rate fell gradually to about 8.3 per cent by 1981. Also, Jamaica's current account deficit fell from nine per cent of GDP to less than one per cent of GDP. The exchange rate depreciated further to J$3.12 to US$1 by 1983 and then to $5.15 to $1 by 1984. These were the largest and most consecutive spells of currency depreciation the country encountered. Congruently, the inflation rate increase to 17 per cent and 35.9 per cent in 1983 and 1984, respectively. With such high inflation rates, the Bank of Jamaica had to intervene.
What replaced the dual exchange rate system?
An auction and allocation exchange rate system was
introduced between 1984 and 1990. Foreign exchange was sold to the highest bidder in most cases. The Jamaican dollar exchange rate was maintained relatively stable via the practising of strong, tight foreign currency distribution controls and more quantitative import restrictions. In 1989, the importation of capital goods for rebuilding placed additional strain on the currency after the economy encountered a negative exogenous shock arising from Hurricane Gilbert in September the year before. This along with a rapid growth in commercial banks credit offerings increased the demand for foreign currency resulting in further depreciation of the Jamaican dollar. By the beginning of 1990, the exchange rate increased to J$7.24 to US$1.
The Bank of Jamaica
consequently restricted disbursement of foreign currency. Commercial Banks were limited to a specific amounts of foreign currency they could sell per week and a quota system was introduced for foreign travel and foreign purchases allowed to each person and business.
This system, plus the demand management policies, were insufficient to keep the exchange rate stable and by 1990, the exchange rate reached J$12.22 to US$1. The reserves were depleted, sometimes negative and Jamaica had to borrow once more.
When was the floating exchange rate system introduced?
Under the guidance of the Washington Consensus recommended by the IMF, Jamaica liberalised its financial sector in 1992. No exchange rate controls meant that foreign currency was supplied on demand.
Reserves quickly depleted and the exchange rate depreciated further to appease demand; jumping to J$25.11 to US$1 in 1992. A rapid increase in prices ensued. The inflation rate reached 60 per cent in 1992, and Jamaica had to borrow once more.
After liberalising its financial sector in the early '90s, Jamaica did not put sufficient control mechanisms in place, and the exchange rate has continued to depreciate since. Jamaica has maintained this free-floating exchange rate system from 1992 to present. The Jamaican dollar traded at US$126 to US$1 at the end day on Tuesday.
- Dr Andre Haughton is a lecturer in the Department of Economics on the Mona campus of the University of the West Indies. Follow him on Twitter @DrAndreHaughton; or email feedback firstname.lastname@example.org.