A conversation on jamaica with Uma Ramakrishnan

Sunday, September 16, 2018

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Following is an interview of IMF Mission Chief to Jamaica Dr Uma Ramakrishnan conducted by Bruce Edwards and released in a podcast on September 13, 2018.

Bruce Edwards: What lies behind Jamaica's recent currency depreciation and what the impact might be on prices?

Uma Ramakrishnan: Policy-making cannot be responding to everyday events because if you respond and react to everyday events, you are going to generate volatility rather than prevent volatility.

Bruce Edwards Editorial Comment: Jamaica's economic reform plan, launched back in 2013, has shown good results for the most part. Employment is at historic highs and external borrowing costs are lower than they've ever been. But economic growth is still slow, and the recent depreciation of the Jamaican dollar has turned attention to [a] shift in the central bank's foreign exchange policy. Uma says the central bank's new commitment towards an inflation rate regime will help stabilise prices and spark growth.

Edwards: What is an exchange rate regime?

Ramakrishnan: An exchange rate policy or exchange rate regime is the way in which authorities manage their currency in a foreign exchange market. The authorities can decide to have an exchange rate that is fixed on one extreme or it can be floating on the other extreme or variations in-between like a currency board of a managed float or crawling peg, or a whole variety of other regimes that go in the middle. Each of those comes with their own pros and cons, and in particular if it were a fixed exchange rate regime, where the rate is fixed in its value against other currencies.

Edwards: Like pegged to a dollar?

Ramakrishnan: Correct. It could be sometimes fixed at an artificially low rate which can trigger all kinds of problems because what would happen if it is fixed at a low rate is that the country would have instability that could arise in the external or what is called the trade balance, which can in itself create macroeconomic instability. So that's to illustrate that every regime comes with its pluses and minuses and a flexible exchange rate comes with its own pros and cons.

Edwards: So what has traditionally been Jamaica's policy and why this recent shift to a flexible exchange rate policy?

Ramakrishnan: Jamaica has always, for a very long time, had a flexible exchange policy, at least in the de jure sense. They have had a flexible exchange regime since the 1990s, so it is a long-standing policy, it is not anything new, it is not a recent shift, it has existed for a while. Jamaica being an open economy, it's a case where the flexible exchange rate actually works well and is relevant, because an open economy, by definition, is subject to a lot of external shocks and the exchange rate is a variable that is there, is a price that absorbs a lot of the external shock. So, for Jamaica the flexible exchange regime is the right regime to follow. But in practice Jamaica has had variations of it, including managing the flexibility so that they target an exchange rate level or a crawling peg.

Edwards: So it has been a flexible exchange rate for some time but managed, but not completely flexible?

Ramakrishnan: Not completely flexible. So the central bank or the Government may act if they see too much depreciation in the movement then there are some sales, or intervention as it's called, that occurs. What has recently shifted actually, within this regime, that has been practised is that the BOJ has introduced what is called the Fx auctions, or in the terminology that they use it is called BFxit, which stands for BOJ foreign exchange intervention trading tool. That is used for BOJ official transactions with the market, the way it interferes with its buying and selling with the market, and the reason why the shift happened from the previous regime to the Bfxit system is that it is a more transparent, competitive, rules-based mechanism for price discovery for BOJ's official transactions. The auction mechanism is part of an ongoing shift to modernise the central bank to eventually move towards an inflation targeting framework.

Edwards: There has been recently significant depreciation of the $J, does this have to do with this recent shift?

Ramakrishnan: The flexible exchange rate, by definition, when we talk about flexibility it's because it goes up and down, and so a flexible exchange rate means that the market forces determine what the exchange rate is in any given day. So it's based on supply and demand. So whether the currency appreciates or depreciates depends on the extent of demand or the currency or the amount of supply of the currency. In our mind the currency has been moving like it should because in a flexible exchange rate this is what one would expect.

In the current context it has to be put in perspective because what has happened is that the US dollar has been strengthening globally. US interest rates have been on the increase, and therefore the US dollar globally has been appreciating and a lot of emerging market currencies and advanced economy currencies have been weakening against the dollar. So the phenomenon that is going on in Jamaica has to be considered in that context; that's one thing.

The second thing is that depreciation has also occurred in the context of portfolio conversion, where Jamaicans are switching from J dollar to US dollar assets. Around about the time after, there was a very large J$58 billion bond redemption which means that the Government paid back a huge bond that it owed the people that matured, and so the money was redeemed and so a lot of J dollar liquidity injection occurred in the market.

Edwards: So this depreciated the value of the J dollar?

Ramakrishnan: There was just more J dollar liquidity that was slushing around and so there was a lot more supply of J dollars which, given the flexibility of the exchange rate, is reflected as depreciation. Once the depreciation kicked in, sometimes the sentiments shift and when people see the depreciation they fear and expectations kick in that more depreciation is coming and then it becomes what we call a self-fulfilling prophecy. So some of it is related to that also. So I think there is good explanation for why this occurred and some of it is sentiment also.

Edwards: What is the role of the central bank in all this?

Ramakrishnan: The central bank has a monetary policy objective that is price stability. It is to achieve an inflation that is in the four per cent to six per cent range as set by the GOJ and that inflation target has been set in a way that is consistent with Jamaica's medium term growth objectives. So the central bank's job is to deliver on the price/ inflation target that has been set. Over time the central bank therefore adjusts its monetary policy levels like the interest rate that they have so that they are able to manage and deliver the inflation outcome that is set as an objective for them.

Keeping the prices low for the Jamaican people is important and I think making it predictable and setting expectations so that people are able to foresee what the inflation is likely to be, which is important for daily planning for businesses and households. What is also important is that the central bank credibly communicates and delivers its inflation objectives.

Edwards: So given that most of the raw materials and goods in Jamaica are actually imported, it seems inevitable that prices will continue to rise, given the situation. Do you worry that the living standards for the people who earn Jamaican dollars — which is the vast majority of people in Jamaica — that these people's living standards will actually decrease?

Ramakrishnan: Yes, I agree that when a currency depreciates that the cost of imported raw materials indeed do go up. But there are two factors that I want to add to what I consider a somewhat narrow reading of the situation. One is that the pass-through of the exchange rate depreciation,

Edwards: You're going to have to explain what the pass-through means.

Ramakrishnan: Pass-through is how much of the currency depreciation actually gets passed to a price. So there are many components of how a good is priced. There are raw materials, labour, capital; exchange rate is another piece of those elements that gets passed through to prices. So exchange rate moving, does not immediately mean a price because there are other components that drives price. Therefore, what is important to consider is what is the pass-through from the exchange rate per se into the inflation.

In Jamaica, the pass-through of exchange rate to inflation has been declining through time, and this reflects the hard earned macroeconomic gains. The costs and efficiency to which production has happened is improving and that's a good thing. The problem right now in Jamaica is that inflation is a little too low relative to the target that is the policy objective of the central bank.

Edwards: So why is it that people are complaining about high prices?

Ramakrishnan: Historically, Jamaica has had high prices, hence the fear of going back to that era of high prices and highly volatile inflation is still very much in the minds of people because they are not yet there. The expectation is still somehow that this is going to reverse to the old times, but that is not the case, the macroeconomic stability is entrenched and we have a problem now where economic activity needs to be stronger, economic growth needs to kick in and economic opportunities have to arise in order to have Jamaica grow; and in order to achieve higher activity the central bank has been responding by keeping interest rates very low – they are at historic lows.

So when you ask about living standards, exchange rate is not the catch-all for living standards. Exchange rate is important and I will not deny that, it has impact if you're earning in J dollars, it does affect that. However, it is not the only variable to look at. There are many things that one should be looking at when considering the broader living standards of Jamaica. For example, job opportunities have increased a lot, unemployment is at almost an 11-year low, poverty declining, interest rates are at historic lows, investment opportunities are available a plenty in Jamaica and economic opportunities and economic growth are what raise living standards, not the exchange rate.

Edwards: As this plays out, and if the prices do rise as people expect — we don't often see prices drop once they've gone up — how do you see all this playing out in the coming months?

Ramakrishnan:Actually in Jamaica, data does show that prices have come down. So, for example, in several instances in the recent past, we have seen deflation, meaning that inflation is negative, which means that the price level is declining in many categories of food, electricity, water, so we have seen inflation come down. So the data shows that the stickiness in price is not necessarily the craze.

What we see in the coming months — price stability is the goal that is the policy objective of the Government and that is the policy objective of the BOJ. The Government has set a medium-term target of four to six per cent inflation and people of Jamaica should expect that the price will be stable. Policy-making has to take a medium-term perspective, policy-making cannot be responding to everyday events, because if you were to respond and react to everyday events you are going to generate volatility rather than prevent volatility.

So in order to have price stability and to be anchoring people's expectations in the medium-term, you need to be thinking in that medium-term context and the policies that they do today are going to deliver those results in the medium-term — inflation is no different. The idea is that price stability is the goal and it is to be delivered consistently for the Jamaican people in the medium term context and that's where the BOJ is right now, and a flexible exchange rate will provide a supporting environment so that it absorbs the shocks that may arise. So you need a shock absorber, and that's the role the exchange rate is expected to play.

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