Understanding this new era in our economy

Friday, August 17, 2018

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The recent public debate on the depreciation of the Jamaican dollar has been ardent and, in some cases, desperate.

Even well-informed stakeholders have become confused, the most surprising being the members of the Economic Programme Oversight Committee (EPOC), who are now arguing that “the transition from a managed float to a free float should be managed”.

That runs counter to its previous support for a floating exchange rate regime.

The country should not forget that immense political muscle was used to get the rate to a real and sustainable level and then resist the temptation to undervalue it again.

This is a new era in Jamaica's march to economic independence. The country has commendably clawed its way out of the deepest part of the economic pit we dug for ourselves over several decades. We have achieved stability that was previously unimagined; unemployment is at a record low, inflation is on par with our main trading partners; our exchange rate is real and sustainable; international reserves are at record levels; interest rates are low and falling; and our current account is largely in balance.

We are finally able to abandon the failed policy of high interest rates and the squandering of international reserves to prop up the exchange rate.

Making the exchange rate flexible made it possible to lower inflation and drop interest rates. Now the country is seeing more protection of the buying power of the poor, higher investment and, as we already pointed out, lower unemployment.

However, even in a flexible exchange rate regime the Government can still intervene in exceptional circumstances. The International Monetary Fund has confirmed its strong support for the Government's flexible exchange rate policy while explicitly acknowledging that the central bank should step in if there are significantly disruptive and “disorderly market conditions” or “excess volatility”.

The questions, therefore, are: What level of distortion justifies intervention, and what degree of intervention is possible without returning to managing the rate? The Bank of Jamaica (BOJ) is in the process of learning how to strike that delicate balance.

Objective data on the fundamentals show that there is no shortage of foreign exchange (FX) for actual transactions. If the recent devaluation is not driven by economic imbalances, then what is causing it?

A thin, underdeveloped FX market like ours is vulnerable to short-term supply or demand peaks and valleys. Low Jamaican dollar interest rates have prompted people to buy US dollars to swap out of US-denominated debt, thereby increasing demand. Sellers of FX have opted to delay sales to see if the rate will slip further. Purchasers are rushing to buy before it slips further. The result is an artificial shortage and a sliding rate.

In the old days, the BOJ would have jacked up interest rates and sold chunks of the international reserves. Now we let it find its floor while we keep our eyes on low inflation and interest rates. Our relatively low inflation and the ample supply of FX indicate that once the panic is over the rate will fall again, much to the dismay of speculators.

Our FX market will certainly evolve to offer more sophisticated products that allow importers to buy foreign currency at predictable rates when they need it. Analysts, we expect, will improve their understanding of this new policy mix. And, hopefully, politically motivated elements will stop stoking panic simply to reap selfish benefits that hurt the country.

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