Choosing the monetary policy stategy from various options

Brian Wynter, Governor of the Bank of Jamaica gives a nice speech on the topic.

Bank of Jamaica is celebrating its 50th year of foundation and so it is time for introspection for the bank. He begins looking at the options at the time of independence:

I will begin with a sketch of the path that was taken after independence and during the post-Bretton Woods era. Among the group of former British colonies in the Caribbean, Jamaica was the first to establish a central bank, followed by Trinidad & Tobago in 1964 and Guyana in 1965. By the end of the 1960s these central banks had taken over the note issuing function of the currency boards that they replaced but would have done little else in the way of exercising discretion over monetary and exchange rate policies. So, while national currencies appeared, they maintained the look and the parities of the old money except that they were now issued by institutions of the newly christened nation states.

B-Woods break up changed this currency board arrangement:

After the break-up of the Bretton Woods system in 1971 and the adoption of generalised floating by the major industrial countries, Caribbean nations, like other developing countries, were faced with the issue of what type of monetary arrangements they should adopt. Typically, the considerations included a desire for policy independence, “balanced growth” and price stability at home, all in the context of continued traditional trade links with the industrial countries. The options they faced ranged from the creation of currency enclaves as in Panama or Puerto Rico, a wide variety of pegging arrangements and institutional structures, to the formation of currency unions such as the one eventually adopted in the Eastern Caribbean. The most liberal extreme, joining the system of independently floating currencies, was not immediately feasible. For the most part, these developing countries responded to the changes in the international monetary system by pegging to the currency of their major trading partner.

However, pegging arrangements came under unprecedented pressure following the oil shocks of the 1970s and the subsequent swings in demand for commodity exports from developing countries. The alternative to the economic compression and restructuring demanded by these sharp changes was international borrowing; indeed, this proved to be the road most travelled. But, as it became clearer in the 1980s that further large-scale borrowing was unaffordable and that economic restructuring was inevitable, the question of suitable monetary and exchange arrangements once again arose.

IN 1980s the carribean economies differed on their mon pol choices:

The smallest states of the Caribbean – member countries of the Eastern Caribbean Central Bank – as well as Barbados, Belize and The Bahamas chose to make adjustments to their economies without changing the exchange rate and, in the process, experienced some loss in competitiveness but not obviously more than elsewhere. In these territories, wage awards and monetary conditions needed to be consistent with low inflation and a stable exchange rate, leaving the brunt of the adjustment process on government finances, employment and output.

The larger states of the Caribbean – Jamaica, Guyana and Trinidad & Tobago – all adopted flexible exchange rates as part of  their structural adjustment programs. The prevailing consensus on development thinking, led by the Washington-based institutions, pointed to the likelihood of greater export diversity, sustainable balance of payments and improved economic efficiency if the adoption of flexible exchange rate regimes was accompanied by other economy-wide reforms.

Jamaica’s episode was interesting:

One outcome of this process that was particularly sharp in Jamaica was its impact on inflation. Even after the initial adjustments to the domestic price level that accompanied these changes tapered off, they had set in motion a wave of negative expectations about exchange rate depreciation accompanied by inflation which, in turn, pushed organized labour into making wage demands to protect living standards. Government expenditure expanded to meet these and other needs which were funded, in large measure, by borrowing. Fiscal dominance, an open capital account and the absence of reserves defined a heavy role for monetary policy in reining in domestic expenditure. A large part of the book “Bank of Jamaica – The First Forty Years’ is devoted to narrating the range of policy responses undertaken by the Central Bank and the uphill fight to maintain macroeconomic stability.

Similar choices are available even now.

We have on the menu essentially the same set of options that policymakers had post-Bretton Woods: pegging (or fixing) the exchange rate, monetary union, dollarisation and independent central banks. The difference now is that we have had 40years of experience since then and have spent a lot of time and energy in discussing some of them as regional issues.

The first three – a fixed peg, a monetary union and dollarisation – all imply relinquishing discretion over monetary policy. They differ in the degree of commitment or reversibility inherent in each regime and, in a sense, what the actual currency units would look like. The answer to the question “what’s in your wallet?” would tell the world what your choice was.

He discusses all these three and says independent central bank is the best. The other three are inflexible and depend on other nations.

An autonomous central bank would be one that is insulated from short-term political priorities both by its terms of reference and by its governance provisions. Its focus on low and stable inflation would be monitored by its reporting to Parliament and by its implementation of an inflation targeting regime which has proven to be an effective anchor for inflation expectations in a growing number of industrial and developing countries. It would retain responsibility for financial stability and would thus have the mandate and the wherewithal to respond to potential threats to stability before they arise and to support  systemically significant entities where the need arises. Such an institution would be of our making, could achieve all of the goals that we think are important to our collective well-being and would see us through the next 50 years proudly holding Jamaican dollars in our wallets.

Nice speech. The various monetary policy choices available and selection of one provides a good reading. Covers many issues in the process.


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