By Al Edwards, Business Co-ordinatorDURING the latter part of last year the economist and tourism czar, Dennis Morrison, wrote a series of articles in his weekly column focusing upon the high interest rate regime and its debilitating effect on the national debt and the economy in general.
Mr. Morrison points to the need to reduce interest rates, and charges that members of the financial sector selfishly behave in a way to force those rates up, a charge which Keith Duncan of Jamaica Money Market Brokers (JMMB) has since soundly rebuffed. While he does point to the need for Government to get its fiscal affairs in order, Mr. Morrison neglected to explain why interest rates are still high and exactly what is required for them to come down.
Mr. Morrison's columns are not the rantings of some third rate journalist or sensation-seeking politician. He is a highly experienced technocrat and a trained economist.
THE BLAME GAME
Therefore, when Morrison continuously raises the question of high interest rates and the havoc they are causing, but conveniently neglects to mention that interest rates are being kept high because the Government is always borrowing, it can be construed that he is being a tad bit economical with the truth (ha, ha I rather liked that! Pun totally intended). What the deliberate omission does is to assist the Government in playing the 'blame game'. Morrison targets the fiscal financial sector, which speculates in order to benefit from the high interest rates. This in turn has caused some to blame the stubborn central bank, which has the power to magically reduce interest rates, but refuses to do so for no reason whatsoever.
Both Dennis Morrison and Omar Davies well know, high interest rates have very little to do with any sort of selfish or irresponsible behaviour from anyone in the financial sector. Interest rates are being kept high simply because the Government hogs the local market, and this demand forces up the price. Consequently, it is impossible for the central bank to push interest rates down below the natural price equilibrium of supply and demand, so BoJ cannot slash interest rates until the Government stops borrowing so much domestically.
Less demand, lower price. Simple result: lower interest rates. You don't need to rush to Economics Made Simple to figure it out. It was Dr. Omar Davies who said clearly in 2001:
" ... proceeds from this bond issue will allow the Government to reduce its presence in the domestic market, thus accelerating the downward movement in interest rates."
SO WHAT ROLE DOES THE BOJ PLAY IN THE COUNTRY'S FINANCES?
Under existing legislation, BoJ advances to central government are restricted to a maximum of 30 per cent of the country's estimated revenue in that financial year. Also, BoJ's acquisition of securities guaranteed by Government is limited to 40 per cent of Government's estimated expenditure in that year. These ratios are not only way out of line with accepted international standards, but in an economy of Jamaica's size, would spell chaos if fully applied. Using available figures for the last financial year as an example, the law would have allowed Government to pressure the BoJ for a maximum of $39.9 billion in printed money, assuming it had paid back all previous such advances. If this had happened, it would perhaps by now cost several thousand dollars to buy a loaf of bread. Proposed amendments to the law, including limiting existing ratios to five and three per cent, have been gathering dust in Parliament since 1997, with the Government showing absolutely no inclination to ever table them for debate. Until those and other amendments are passed and the central bank is made legally independent, technically, the only thing standing between the country and much greater economic chaos is the backbone of the central bank Governor and his staff.
In fairness, the present Minister of Finance has never directly pressured the BoJ to print money. It also appears that other Government personnel would love to see him do so.
To his credit, the present Governor of the Bank has a consistent record of resisting political pressure to print money, and behaves as if the central bank is fully independent. Unfortunately, especially when a central bank is not fully protected by law, a government can always find ways around a stubborn Governor.
A central bank is by law banker to the government, so if Government carelessly runs itself bankrupt and goes into overdraft, the BoJ cannot just simply bounce its cheques and allow national chaos, especially when the Government cheekily hands the Bank securities in lieu of cash and so does not have to correct the overdraft.
When a government carelessly makes a mess of its fiscal affairs, it also becomes totally impossible for a central bank to properly fulfil its mandate and successfully implement monetary policy. It also provides a scapegoat with whom it can share the blame of economic woes. Perversely, this goes hand in hand with Government taking all the credit for six consecutive years of low inflation and reasonable stability in the foreign exchange market, factors engineered largely by the central bank. The following three propositions illustrate the workings of mind of the Government.
Monetary policy has been working and has delivered results
Fiscal policy has been a dismal failure
Solution to fiscal problems tamper with monetary policy thus building a mountain of debt that sends the country precipitously close to default.
WHAT IS CLEAR, IS THIS
Monetary policy is the only plank of economic policy that has delivered desirable results in the last decade (i.e., low inflation and relative exchange rate stability) and has only failed to deliver where it has been hampered and sabotaged by the mess of the fiscal situation (i.e., not being able to lower interests rates further).
The incompetent administration of fiscal policy is the single biggest reason behind the dire economic straits that the country now finds itself in.
What must not be allowed to happen is that a government in political and financial desperation and in the face of a snowballing fiscal-induced economic crisis, seeks to appoint committees to figure out ways to tamper with the central bank and force it to print money. One such attempt is a committee appointed by the Prime Minister's Office with a mandate to devise ways that the special deposits held by the BoJ be freed and used to 'stimulate' "growth and development projects". This particular scheme clearly illustrates just how desperate a government has become and what foolhardy measures it will take to address its fiscal woes. What must be recognised is that these 'special deposits' in question do not even belong to the BoJ, they are the property of the commercial banks. So what this committee is supposed to do is come up with an excuse for the Government to use the central bank to rob the financial sector for short-term purposes.
Yet another committee has been appointed I understand, this time armed with the idea of creating a Monetary Policy Committee to help the central bank implement monetary policy. Never mind that in the countries where such committees exist, those central banks are independent, and the members of such committees are highly trained technical experts in economics and finance. The objective of this committee? To force the central bank to artificially lower interest rates below the market rate dictated by demand and supply, so government can forcibly reduce its debt stock. There are those who point out that the inevitable consequence of this move will be that investment funds will shift towards US$ instruments, causing the dollar to start running once again, which in turn will push inflation out of control with a spiral of price increases.
Although the Partnership for Progress are trumpeting turning to US$ indexed bonds as a way to reduce the debt by about $5 billion, some might say it allows the government to blame the central bank and the financial sector for what is happening in the market, and point to the fact that it has done its part and reduced its debt stock. What has to be borne in mind among these bright minds, is that a rapidly sliding dollar can easily multiply the total debt stock more than any artificial drop in interest rates can reduce it.
MONETARY POLICY OPERATIONS
The stability tailored by the monetary policy operations of the central bank was supposed to be a platform for the Government to build on, to provide the conditions for the economy to grow. Instead, Government not only failed to stimulate meaningful growth, but concentrated solely on stability as if it were an end in itself and not a necessary prerequisite for other things. In addition to limiting the BoJ's ability to slash interest rates, a failure to stimulate high production levels helps to maintain trade and balance of payments deficits and leads to less than desirable inflows of hard currency. This plus a refusal to skew borrowing toward overseas sources creates a vulnerable NIR and a shallow foreign exchange market. This produces an inherent difficulty in managing the latter with the former, especially when the Government has a habit of occasionally undermining investor confidence.
In an import-dependent economy, devaluation has a direct pass-through to domestic prices, as events last year aptly illustrated.
As Bear Stearns points out in its November 2003 report, the central bank must also be mindful of the little-known fact that every 10 per cent devaluation increases the nation's J$ debt service obligations by 0.7 per cent of GDP, higher than the 0.4 cost of a similar percentage point increase in interest rates. As the Economic Intelligence Unit (EIU) states in its October 2003 country report on Jamaica:
"... monetary policy is complicated by the dire state of Jamaica's public finances persistent pressure on the local currency since mid-December 2002, in response to the government's failure to contain the fiscal deficit, required strong action by the monetary authorities ..." According to Bear Stearns, the central bank's policy dilemma is "obvious and extreme."
