Ian BoyneOPPOSITION LEADER Edward Seaga has essentially snubbed the Budget Debate as pedestrian, and has instead initiated a serious intellectual discourse on economic strategy by fundamentally challenging the economic direction of Finance Minister Omar Davies.
In what was more like an academic presentation rather than the usual parochial and histrionic Budget Debate, the Opposition Leader again demonstrated his intellectual acuity and grasp of overarching economic issues by proposing a radical reordering of our economic strategies.
"A strong case exists to examine the option of either a currency board with a fixed rate of exchange or an independent central bank with a special regime to maintain a pegged rate as the means of ending the frustrations of a stagnant, debt-ridden economy", Seaga told Parliament on Thursday.
No doubt speaking above the heads of some in the nation's Parliament, Seaga went on to fundamentally challenge the Patterson Administration's philosophy of regional integration by saying that "these options have far greater potential for the Jamaican economy than being shackled to a Caribbean Single Market and Economy (CSME) in which the market size is insignificant; or to be further shacked with a Caribbean monetary union, which is likely to be still-born or if surviving would be pointless and futile in promoting the adoption of a whole new currency regime to satisfy a tiny fragment of Jamaica's trade".
FIXED RATES AND
ECONOMIC CRISIS
Seaga noted that there was a time when promoting a fixed exchange rate as "the cornerstone of economic policy" was heretical, "certainly in IMF circles", but he noted that many countries had now been adopting pegged exchange rates instead of the managed or free floating regimes. Seaga drew on what he said was conclusive evidence from cross-country empirical studies showing that countries with fixed exchange rates grew faster and had lower inflation and interest rates than countries without.
Expounded Mr. Seaga: "In Jamaica's case the benefit of a fixed exchange rate would be the capability to drive interest rates down without impact on the rate of exchange. With a fixed exchange rate, liquidity could accumulate in the banking system without the need for central bank intervention to sop up the liquidity in order to ensure that the extra funds are not used to depreciate the exchange rate. As liquidity accumulates, banks would have to reduce rates as in the case of any commodity in surplus."
Seaga called for a fixed exchange rate "as the centrepiece of a macroeconomic place to stabilise the economy by a combined low-interest rate, low-inflation strategy, a combination that has eluded the Jamaican authorities for more than a dozen years since 1990."
The Seaga challenge is on the table and I would like to be one of the first to respond to this raising of the bar of economic discussion in Jamaica.
First, while Mr. Seaga quoted some academic studies and some reputable scholars, his zeal to promote a fixed exchange rate has run ahead of a judicious and nuanced handling of the empirical data. He might have been a little more cautious about recommending pegged exchange rates and currency boards as a solution to our economic challenges had he seen the latest issue of the International Monetary Fund's quarterly, Finance and Development (March 2004).
CURRENCY UNIONS
In an article titled 'The Continuing Bipolar Conundrum' by Andrea Babula and Inci Otker-Robe, it is noted that the major currency crises of the past decade have been associated with pegged exchange rates, either of the 'hard' or 'soft' types (hard pegs are like formal dollarisation, currency boards or currency unions, while soft pegs are conventional fixed pegs vis-a-vis a single currency like the U.S. dollar or the Euro or a basket of currencies). "The intensity and scope of the crises which were accompanied in many cases by a collapse of the banking system and economic activity were overwhelming", say the authors.
Countries are particularly prone to crises in this age of deep financial integration and the liberalisation of capital controls. The authors in the IMF quarterly journal: "In our study, we looked at the de facto exchange rates regimes of more than 150 countries. We found that pegged regimes (the group of hard and soft pegs) are indeed more prone to currency crises than floating regimes (including managed and freely floating regimes), particularly in countries that are more integrated with international markets."
Mr. Seaga might also have been interested to know that "while more than half of all countries were still pursuing various forms of pegs at the end of 2001, the number of such regimes declined significantly (from about 80 per cent in 1990) and their composition shifted markedly from more crisis soft pegs to less crisis-prone hard pegs". In other words, countries are moving to either greater flexibility or greater rigidity. So let's bring on the discussion on currency boards!
FINANCIAL SECTOR CHALLENGES
Hong Kong managed its financial sector challenges quite well with its currency board and Malaysia returned to a fixed peg in 1998 following a float in 1997. Also, Ecuador went for
full dollarisation after the float of its crawling bond. So Mr. Seaga has, indeed, raised an issue which is very germane in macroeconomic discourse.
But the discourse is more nuanced than Mr. Seaga has presented it. It is not as clear-cut, and the empirical data is not conclusive, as he has put forward. Indeed, the leading scholars who are looking at these matters all admit that the data is inconclusive.
NO CLEAR-CUT EVIDENCE
In a paper just released by the IMF (April 15) by Assaf Razin and Yona Rubinstein and titled Growth Effects of Exchange Rate Regimes on Capital Account Liberalisation in the Presence of Crises: A Nuanced View, it is stated that, "indeed, it has been conspicuously difficult to identify clear-cut empirical real effect of exchange rate regimes on the real side of the open economy - the literature has had a remarkably difficult empirical task to identify clear-cut empirical real effect of monetary regimes on the open economy."
The issue of which exchange regime we adopt cannot be divorced from economic and social context. My position is that the macroeconomic indicators in Jamaica are trending in the right direction and now would be the absolutely wrong time to make the kind of radical changes being recommended by Mr. Seaga. Pegged regimes might be the best option for countries suffering high inflation and other macroeconomic disequilibria. We just had six consecutive years of single-digit inflation and are currently on track for single-digit inflation again.
A Government has three main policy choices - pegging the exchange rate, keeping the capital market open and conducting an activist monetary policy.
The 'trilemma' which Governments face is aptly summed up by Alan Taylor in his excellent historical review of exchange rate policy over the last 100 years in the article, Global Finance: Past and Present, also in the March 2004 issue of the IMF's authoritative Financing Development quarterly: "The trilemma arises because a Government can achieve only two of these policy goals at any one time. For example, it can achieve exchange stability and an open capital market by adopting a permanently fixed exchange rate but it must give up monetary independence. If a Government opts for monetary independence and an open capital market, it can float the exchange rate but cannot achieve exchange stability. Finally, if a Government chooses exchange stability and monetary independence it abandons the goal of capital market integration." The trilemma has major implications for monetary policy.
But Taylor concludes from an abundance of research: "We conclude that, in general, over the wide historical experience covering more than 100 years, floats have permitted more interest rate independence than pegs except when pegs were combined with pervasive capital controls as under the Bretton Woods regime."
Pervasive capital controls is out of sync with global capitalism and Jamaica would be immediately punished by the international-and indeed-local capital markets for any such move.
Jamaica is not Hong Kong or Malaysia. We cannot import models without regard to contextual specificity. Globalisation imposes real constrains on states and one of the things which Eddie Seaga needs to realise is that the world has changed profoundly since the early 1980s when he was in power. While he is still doubtlessly a visionary, he can often, paradoxically, be caught in a time warp.
HIGH COST TO THE POOR
The research also shows that fixed or pegged exchange rate regimes impose a high cost on the poor and economically and socially vulnerable, which would be an unintended consequence for a politician like Seaga whose entire career has been pro-poor. Governments need the autonomy and manoeuvrability to intervene on behalf of the marginalised.
In a February 2004 IMF Working paper, Inflation Targeting and Exchange Rate Rules in an Open Economy, Eric Parrado says that "the main findings of this paper are that, depending on what shocks affect the economy the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime... with regard to the exchange rate regime, the analysis concludes that the social loss is much higher under managed exchange rates than under flexible rates if there are foreign and real shocks..."
And in small, open economies like ours, with strong integration with the global economy, our vulnerability to exogenous shocks is high. We have to be wary, therefore, of exchange rate regimes which are associated with financial sector crises.
The name Stanley Fisher, former IMF first deputy managing director is one which is prominent in any study of exchange rate regime. He is the man who famously praised Omar Davies as one of the most effective finance Ministers he has met. He is an unflinching advocate against fixed exchange rates. In a presentation before the Hoover Institution in 2001, he noted that "Each of the major international capital-related crises since 1994-Mexico in 1994, Thailand, Indonesia and Korea in 1997, Russia and Brazil in 1998 and Argentina and Turkey in 2000 - has in some way involved a fixed or pegged exchange rate. At the same time countries that did not have a fixed or pegged exchange rate - among them South Africa, Israel in 1998 and Mexico in 1998 and Turkey in 1998 - avoided crises of the type that afflicted emerging market countries with pegged rates".
The question we must ask ourselves is whether vulnerability to external shocks in this era of deepening financial globalisation is any less today or will be in the future.
We are already moving in a direction of macroeconomic stability, though Mr. Seaga is right that very serious structural problems remain such as low productivity, sluggish export growth, weak inter-sectoral linkages and inadequate educational investments.
Mr. Seaga's criticisms of the proposed CSME are weak. While Caribbean integration is no panacea, it represents an improvement over our very small domestic market. It's not an either-or situation-either involvement in CARICOM or further strengthening of our relations with third countries. Indeed, our deepening of regional integration facilitates greater third country market penetration.
But Eddie Seaga has once again raised the bar of budget presentations and has reminded the critics that he is still an intellectual force to be reckoned with.
Ian Boyne is a veteran journalist. You can send your comments to ianboyne1@yahoo.com.
