Wayne Robinson | A response to the PSOJ’s blunt talk on interest rates

In a recent article published in The Gleaner, titled ‘PSOJ sees credit squeeze after ‘blunt’ BOJ rate hike’, the Private Sector Organisation of Jamaica is reported to have expressed the view that it is against the recent interest rate decisions taken by the bank for several reasons.

These include, inter alia, the bank’s actions being similar to those taken in the 1990s, which resulted in a significant economic fallout; there are other instruments the Bank of Jamaica, BOJ, could have utilised before resorting to hiking interest rates; and there could be capital flight, given the restrictive policies being pursued by the central bank.

Higher interest rates will adversely affect businesses and anyone who has a loan or plan to borrow, a factor that the BOJ’s Monetary Policy Committee, MPC, weighs very carefully in its decisions.

However, all Jamaicans are feeling the effects of inflation, which is at an almost eight-year high of 9.7 per cent as at January 2022, up from 4.7 per cent a year earlier. Food prices have jumped by an average of 10.1 per cent in a year, based on Statin’s CPI data. Also, utilities, rent and other housing expenses have jumped by an average of 10.9 per cent. I stress ‘average’, as electricity and some food items have gone up by much more than the headline inflation rate.

Let us not forget that the Government and Parliament have stipulated that BOJ’s primary responsibility is to achieve and maintain low and stable inflation. With this background, we wish to respond to selected points raised in the article.

BOJ should ‘wait and see’

Similar to many other central banks around the world, BOJ took early actions when its forecast signalled that the 4-6 per cent inflation target, given by the Government, would be breached over an extended period from the latter part of 2021 into late 2022. Following successive policy adjustments, the MPC’s recent decision to further tighten monetary policy at its last meeting was informed by what it was seeing and its assessment of the outlook:

1. Inflation has accelerated and is significantly above target. Inflation at January 2022 of 9.7 per cent remained above the upper limit of the bank’s target range and this breach is projected to persist over the next 10 to 12 months.

2. While international commodity and shipping prices had declined in the early half of the December 2021 quarter, there have been subsequent reversals, and the impact of past increases has had a stronger-than-projected pass-through to local prices. This problem has been exacerbated by the Russian invasion of Ukraine. The ongoing shock to international commodity prices has also contributed to a further rise in inflation expectations, which will in turn feed into actual price increases.

3. The prospects of earlier and stronger monetary tightening among Jamaica’s major trading partners may precipitate capital outflows and pressures on the exchange rate, if domestic monetary policy is not appropriately aligned.

4. Underlying demand pressures have been threatening the stability of the foreign exchange market and, with it, diminishing the prospects of inflation returning to the target range.

Those four factors clearly suggest that the central bank does not have the luxury to ‘wait and see’. Further, as we have explained, and as was reiterated in the article, it takes time for monetary policy actions to have an effect, therefore, policy delay or inaction can be very costly. The BOJ is not alone on this as, since 2021, some 43 central banks across the world have acted by raising rates.

Not a repeat of the 1990s

Jamaica’s current economic environment is markedly different from the early 1990s. The substantial escalation in domestic inflation during the 1990s occurred against the backdrop of the removal of exchange controls and inadequate supporting policies, including expansive and unsustainable fiscal policies and low foreign reserves, which led to sharp depreciations of the Jamaican currency and therefore influenced high market interest rates.

Jamaica had an unstable macroeconomy, which was one of the major impediments to growth.

This time is different. Jamaica has more sound macroeconomic fundamentals. Also, although large and protracted, the international price shocks are not likely to be sustained indefinitely. The banking system is more robust, and our scenario analysis and stress testing suggest that it is resilient to shocks, including interest rate shocks.

Therefore, if we are able to stabilise and reverse the rising inflation expectations in the near term and fiscal policy remains on a sustainable path, it is unlikely that we will see a repeat of the macroeconomic conditions of the 1990s, which contributed to the ‘1990s business collapse’.

Use of other tools

BOJ has, in fact, deployed a range of policy instruments in the fight against inflation and is actively contemplating others. The package of policy initiatives pursued by the bank includes a significant expansion in sales of foreign currency via the foreign exchange intervention and trading tool, B-FXITT, to approximately US$677.6 million for the fiscal year to end-February 2022, well above the sales of US$401 million recorded over the comparable period of FY2020/21.

The bank also sold US$503.2 million directly to the energy sector over the same period, well above what was sold during the previous period. In addition, there has been a more aggressive absorption of Jamaica dollar liquidity via the weekly auctions of the BOJ’s 30-day certificate of deposit. The BOJ in December 2021 also adjusted the foreign currency net open position limits for deposit-taking institutions to support its fight against destabilising movements in the exchange rate.

Interest differentials

Why does interest differentials matter more so now?

Bank of Jamaica is of the view that interest rate differentials will play a more significant role in influencing capital movements, as economies around the world are pivoting away from ultra-low interest rates, that is, from the zero-lower bound.

Interest rates on Jamaican-dollar deposits and money market instruments in Jamaica are still relatively low and, more importantly, are actually negative after accounting for inflation. So, as foreign interest rates rise, the returns on foreign currency investments become that more attractive in this environment, and the rational investor will naturally gravitate towards such assets.

It is in this context that the heightened prospects of monetary policy tightening in the US may result in capital outflows, and could cause pressures on the exchange rate if domestic monetary policy is not appropriately aligned.

BOJ welcomes diverse views, and we are very mindful of the impact our actions may have on businesses. However, we hold it as self-evident that high, unpredictable inflation is the most insidious way of impoverishing the majority of Jamaicans.

Low, stable, and predictable inflation is considered more important and more conducive to long-run, sustainable GDP growth, wealth creation, and the amelioration of poverty than the temporary fillip to economic activity that may be provided in the short run by loose monetary policy.

Loose monetary policy in the face of high and rising inflation is not a recipe for economic growth.

Wayne Robinson is senior deputy governor of the Bank of Jamaica.wayne.robinson@boj.org.jm