Delroy Hunter | Learning from the mishandling of post-pandemic financial affairs
Jamaica has not consistently benefited from the most prudent management of its financial affairs, neither in the fiscal nor monetary policy sphere.
However, we have taken great strides in this respect over the last decade or so. For instance, we now have an independent central bank with a highly competent monetary policy committee with a remit to achieve and maintain price stability.
The Bank of Jamaica, BOJ, has clearly signalled its commitment to its mandate, and is demonstrating that in exigent circumstances it can stay focused without heeding the consternation of the private sector, or succumbing to implicit political pressure related to the concern that its actions could push the economy into recession.
The Jamaican government, through the Ministry of Finance, has adopted fiscal rules that remove some fiscal policy discretion and is establishing a fiscal council to signal that it intends to adopt, and to impose on future governments, a more disciplined approach to fiscal management.
These are substantial accomplishments and clear indications that, after decades of fiscal profligacy and ineffective monetary policy, we have learned that economic progress comes with taking hard decisions.
But can we extend our learning from the current fight against inflation in order to derive additional benefits from the more prudent management of our financial affairs?
Persistence of inflation threat
The current circumstances can teach us several important lessons or, at minimum, reinforce what we have already learned. Since reinforcement is an important part of learning, as it increases learner retention of important facts, I make no distinction here between learning potentially new facts and reinforcement of salient facts already learned.
Not the least among the lessons is the fact that bouts of high inflation, or threats thereof, are likely to be recurring events in the nation’s economic life and we should expect – in fact, demand – swift and appropriate action by the competent authorities, because the ‘delay or do nothing’ and the ‘too little too late’ options are costly.
Consider the case of Turkey, where it is said that President Erdogan told his central bank governor to cut the policy interest rate and to keep reducing it to single digit to increase economic growth. Turkey currently has inflation around 80 per cent, the highest in nearly a quarter-century, and the lira has lost about a third of its value just this year alone. This kind of interference by a government in monetary policy decision-making will, almost surely, exacerbate the inflation problem, and it is a clear lesson about a path we should not take.
Closer to home, perfect hindsight now suggests that the government of the United States might have been too generous in providing pandemic-related fiscal support to households and businesses. This not only contributed to the demand-driven portion of the high post-pandemic inflation because of the inflated – pun intended –bank balances of its residents, but also created distortions in the labour market, as workers were able to delay their re-entry after the reopening of the economy, which increased the supply-driven portion of inflation. Confounding this chain of events, the US central bank, the Federal Reserve, delayed its response to the spike in inflation on the premise that it was transitory. The response, once it got under way, has been robust and has already led the economy into a technical recession that seems likely to get worse.
Despite this, the potential damages arising from persistent high inflation and questionable policy responses are likely substantially higher than the costs associated with the temporary increase in interest rates. If we learn this lesson, then we all should play a role in ensuring that we select the best candidates for leadership roles in our fiscal and monetary affairs, task them with mandates consistent with key national developmental goals, institute appropriate oversight, and let them do their job.
While we should remain vigilant about their actions, we should not be impediments to their exercise of appropriate mandates that are clearly communicated.
Financial development matters
Whether a more developed financial sector enhances a country’s capacity to fight inflation and, more broadly, manage its financial affairs should not be the subject of much debate. More developed financial markets boost the efficacy of the transmission of monetary and fiscal policies to the real economy.
For instance, if the banking sector provides a large proportion of capital to the business sector, tighter monetary policy will be more effective in reducing business investment in periods when banks have less liquidity, or if firms obtain floating-rate loans with interest rates tied to the monetary policy rate.
Similarly, if a large proportion of the country’s economic activity is conducted by firms that are listed on stock exchanges, monetary policy transmission could be more effective, as higher policy rates reduce stock prices and, consequently, the use of company stocks as currency in investments via acquisitions.
Financial markets can also provide policymakers feedback about the appropriateness or inappropriateness of specific monetary and fiscal policies. A recent example of this occurred in the United Kingdom, where, in the presence of high inflation and a delayed and less-than-robust monetary policy response by the Bank of England, the new short-lived government led by Liz Truss announced an expansionary change in fiscal policy to be funded by previously unplanned borrowing.
This took place even though the UK has an established fiscal council and fiscal rules. The financial markets provided clear feedback to the government: sovereign bond values had a steep decline, with the yield on the 10-year bond experiencing the highest-ever one-day increase, and the pound reached its lowest value relative to the US dollar since 1985.
An immediate outcome of these financial market responses was a threat to the stability of British pension funds, which hold a substantial amount of government bonds, and a large increase in the cost of paying the debt that would have been incurred to provide the fiscal benefits.
So, what is the lesson for financial development? Academic research provides a long list of important benefits derived from developed financial sectors. These include greater mobilisation of savings, more efficient diversification, risk management, capital allocation, information sharing and international financial integration, and higher levels of economic growth and social welfare.
Seeding the market
We can append to this list more effective monetary and fiscal policy transmission. Therefore, it is incumbent on us all to expend all efforts necessary and practicable to foster financial development.
I have previously pointed to the notable absence from the local financial market any inflation-indexed instrument, which would provide positive inflation-adjusted returns to fixed-income investors, while simultaneously allowing for the extraction of liquidity from the economy.
The leadership of the Jamaica Stock Exchange and private entities such as Sagicor, Sygnus and others are doing admirable work to increase the depth of, and access to, the financial sector. More can be done on this front to, for instance, broaden the individual investor base in the stock market.
In an article in the Mona Business Review titled ‘Unleashing the Power of the Stock Market to Spur Economic Growth and Create Wealth’, I suggested that we could significantly increase the number of individuals participating in the stock market and unleash the power of their savings through a one-time seed grant from unclaimed bank balances to invest in the stock market. Eligibility would require good savings habits, investing own funds in the stock account, and maintaining the investment for a minimum number of years.
There is also the need to attract to the formal financial sector the relatively large proportion of unbanked Jamaicans, using more creative securities. I am not aware of any prize-linked savings accounts; that is, savings accounts that also offer depositors the chance to win cash prizes in proportion to their deposits. Though Jamaicans have been ‘throwing pardner’ forever, this savings instrument has not been successfully incorporated into the formal financial sector.
Delroy M. Hunter, PhD, is the Serge Bonanni Professor of International Finance at the University of South Florida.firstname.lastname@example.org