Samuel Braithwaite | Exploring the BOJ interest rate hike

A s of 2017, the Bank of Jamaica, BOJ, by law has a singular mandate, which is to maintain low and stable inflation.

While it should be the primary mandate, the BOJ needs to pay greater attention to the foreign exchange market. It should jump-start the market for forward contracts.

The central bank already conducts auctions in the forex market, thereby allowing market forces, as opposed to their discretion, to dictate outcomes; surely the same can apply to the market for forward contracts. There are central banks, such as the Central Bank of Nigeria, which already do this.

Indeed, when a market fails to deliver a product, then it is for non-private actors to fill the gap. Instead of working on the market for forward contracts, it appears as if the BOJ is playing a long game and waiting for the volatility to settle, as the expectations of market agents are ‘reprogrammed’ to accept the new dispensation, where the central bank has a reduced footprint in the forex market. Time will tell how this strategy works.

To the BOJ’s credit, it has a war chest called the net international reserves, NIR, for which there seems to be an unofficial floor of US$3 billion. At the time of writing, the NIR was close to US$4 billion, an all-time high.

This war chest, in addition to the BOJ now being independent of the executive arm of government, both add to the central bank’s drive towards increasing its credibility as the initiator of monetary policy. Indeed, after decades of poor monetary and fiscal management, we can understand the need to build credibility not simply by words, but by actions.

At the sixth meeting of the BOJ Monetary Policy Committee for 2021, the MPC decided to increase its policy rate by 100 basis points, from 0.5 per cent to 1.5 per cent. This is the first increase since the BOJ embarked on inflation targeting in 2017. Indeed, between July 2017 and August 2019, the BOJ consistently lowered the policy rate from 3.75 per cent to 0.5 per cent. This lowering of the policy rate was in keeping with a relatively low inflation rate, which even fell below the 4.0 per cent floor at times.

The rationale for the 4-6 per cent target rate of inflation – a range set by the Minister of Finance – is that such a target is acceptable to support a developing economy that we want to grow. Developed economies can sustain lower rates.

Throughout 2020 and for most of 2021, the BOJ kept interest rates steady and could have reversed course by, say, 50 basis points as inflation rose back to the 4-6 per cent band. Instead, the bank kept the rate low, no doubt influenced by the ongoing economic disruptions brought on by the COVID-19 pandemic. This is indicative of the view that the BOJ is not slavishly changing the policy rates as consumer prices move up and down. However, it is clear they could not ignore the inflationary pressures now facing the economy and decided to step lightly on the brakes.

The idea is not necessarily about bringing down inflation, which is largely externally driven and on the supply side, but more about not adding fuel to it.

The increase in the policy rate is more a signal to the market, a nudge. Some commentators who disagree with the rate hike note that the BOJ cannot influence external inflationary pressures, and further, such supply-side pressures are likely to subside over the next six quarters or so. There is truth in this view.

However, the BOJ is seeking to influence actions on the demand side. But it’s uncertain as to how significant the elasticity of aggregate demand is to the recent changes in the policy rate. There’s unlikely to be any local research that can shed sufficient light on the issue, as we have never been in this situation before.

Indeed, the policy rate is at an historic low, and the country and the world are in the throes of a pandemic. The BOJ is sticking to its rule. Like the DLS or Duckworth-Lewis-Stern rule in cricket, the inflation-targeting regime will not always deliver a position which we agree with, but that position will be one which is relatively consistent with other decisions.

Of course, the monetary policy rule is not as easy to implement as the DLS rule and will be more discretionary. Further, the adage applies: You can take a horse to water, but you can’t make it drink. Central bankers are not dictators. In the United States, the Federal Reserve sets targets – not inflationary ones but the Fed Funds Rate – however, the market need not follow suit, and in times of turbulence it does not, resulting in the need for extraordinary initiatives; for example, TARP.

It is a given that most loans given by commercial banks are consumer loans. Consumption, of course, is a good thing, but when much of what is consumed by way of these loans are foreign products, such as motor vehicles, then we must consider other knock-on effects on the exchange rate and inflation.

It’s not surprising that consumers would have taken advantage of the low rates to purchase more cars within the past two years than would ordinarily be the case. New information suggests that the demand for cars has fallen off this year relative to 2020, no doubt given the fall in incomes and the continued uncertainty of what the next year holds.

Notwithstanding, it is possible that the interest rate nudge by the central bank might very well encourage persons to bring forward their decisions to buy cars, or even houses, and lock in the current low rates, as the higher rates are expected to result from the BOJ decision.

The current stock of new cars might move even more swiftly off the lot in this period, when auto sales usually increase as the new year beckons. However, the demand is likely to fall for cars which are yet to board a ship, and for which higher prices were bound to be applied, with or without the central bank’s rate change. The BOJ gets its wish of tempering medium-term demand, and car dealers get rid of stock they probably would not have sold, if not for the nudge of higher rates.

Even when commercial banks react to the rate hike, the expectation of further increases remains and consumers might very well react to it, all other things being equal.

Loans to the private sector, especially in a situation where banks have already given much concession to firms, especially MSMEs, is a cause for worry. We must turn to the fiscal side to see what relief can be given to struggling firms, especially MSMEs. The significant relief, given the still-fragile fiscal space the country is operating in, is a hopeful sign, but if the choice were between lobbying the monetary authority or the fiscal authority, it would be to look at the latter.

The strategy cannot be one of calling for the BOJ to reverse its decision. The central bank cannot, and should not, bow to any pressure. It would lose credibility if it reversed course at any meeting in the near future.

What stakeholders can do is to seek to influence future decisions, which will either be about holding the rate at 1.5 per cent or increasing it. Greater clarity on the conditions that will warrant an increase should be sought from the BOJ. It should be noted that while the full minutes are not published, a summary is published for public consumption on the bank’s well-designed website.

Finally, we must be careful how we quote the International Monetary Fund. Indeed, the IMF has provided general and balanced comment that could easily be used by the BOJ to justify its decision to increase the policy rate, just using select parts of the statement.

Samuel Braithwaite is a lecturer in the Department of Economics, University of the West Indies, Mona.

samuel.braithwaite@uwimona.edu.jm