'Fix the J'can economy'

What is happening now?

THE PRICE of gold has been on a decline, falling from a high of US$1,800 per ounce last September to a current low of less than US$1,350.

On Monday, the price fell by nine per cent, its largest decline in 30 years. The drop in price came about because of a fall in consumer and investor demand. Since 2002, the price of gold skyrocketed as investors bought the precious metal to safeguard their investment from inflation.

Now, in this fragile international economic climate, consumers are spending their limited income on necessitates rather than luxuries and investors are selling any risky assets in their portfolios.

Most of the gold demand normally comes from China and India, but the Chinese economy fell short of the eight per cent growth predicted for the first quarter of this year, which has had a negative impact on gold demand.

This, coupled with news that Cyprus might sell some of its gold reserves to help pay off its debt, is putting a downward pressure on the price of this precious commodity. Gold is not the only commodity that is losing value; the price of silver and copper is also falling and the price of crude oil is at its lowest in nine months.

What does this mean?

The global economic landscape remains fragile as investors, consumers, producers and governments worldwide desperately try to find the right balance of actions/policies that will restore economic stability and increase economic performance in each country.

Jamaica and Cyprus are two of the most affected by previous bad policy decisions, while Japan, for example, has not been enjoying the growth spurts that they would like. Each country has been facing its own problems and has been tailoring solutions to solve their individual situations.

In Jamaica, the exchange rate was rapidly depreciating, which was seen by many as a negative blow to consumers and producers who demand large volumes of imports. The Jamaican Government seems to have negotiated a deal to be signed shortly with the International Monetary Fund (IMF) and other multilateral institutions, which appears to have stabilised the currency at approximately $100 to one US as of this time last week.

In Japan, the situation has been the opposite; the government has been deliberately devaluing their currency (yen) to make Japanese goods appear cheaper to the rest of the world. This is in an attempt to improve the competitiveness of Japanese products so the country can sell more internationally.

Can the Jamaican economy improve?

As people's real income falls on average and cost of living increases at the same time, governments must find the balance between fiscal policy (tax and government spending) from the Ministry of Finance point of view and monetary policy from the Bank of Jamaica, necessary to increase productivity in the economy.

Fiscal policy should not give tax breaks to the wealthy foreign investors, but should provide incentives to local firms to increase productivity, increase employment and profit sharing. It should attempt to redistribute income to the lower income earners through tax policy, and efficient social programmes. Monetary policy from the Bank of Jamaica can also contribute; by lowering interest rates, the money supply will increase, which should increase people's demand since more money will be circulating in the economy.

However, these policies are only effective if the medium through which they enter the real economy is operating efficiently. More specifically, the central bank can influence the economy via interest rates, only if the government policy rate is successfully transferred to the retail lending and deposit rates.

How does this process work?

If the Bank of Jamaica, for example, increases or decreases its policy interest rate, then commercial banks should respond accordingly by transferring this change in the central bank's policy rate to the retail lending so that investors can benefit.

This process referred to as interest rate pass-through, ultimately determines the effectiveness of monetary policy since it is the retail rate that truly influences the market demand and supply of loans and deposits. By increasing the availability of credit, monetary policy can have real impact on economic activity such as investment and overall growth in gross domestic product.

Is there pass-through in Jamaica?

Results from Haughton and Iglesias (2012) show that Trinidad and Tobago, St Lucia and the Eastern Caribbean States have high interest rate pass-through, while Jamaica, Haiti and Guyana have low pass-through. Interest rate pass-through is low in Jamaica as profit-driven commercial banks do not transfer the benefits of a lower Bank of Jamaica rate to the real economy through the retail lending rate. Interest rate pass-through has also been low in some European countries. IMF officials have compared the current situation to a clogged pipe, where water cannot flow freely. If this pipe isn't cleared, the flow of investments cannot increase and the economy will remain stagnant.

Dr André 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 editorial@gleanerjm.com.

The global economic landscape remains fragile as investors, consumers, producers and governments worldwide desperately try to find the right balance of actions/policies that will restore economic stability and increase economic performance .