Davies, the Exchange Rate and Inflation

Published: Sunday | January 20, 2008

Yes, Dr. Davies, maybe I was unfair to you in some respects in my January 6 piece. As you wrote on January 15, it's perhaps not unreasonable for a finance minister to leave himself wiggle room in case of unforeseen.

So, I apologise for implying that you delibrately misled the country by publicly predicting a six to eight per cent annual price rise, while privatekly assuming a double-digit rate in costing the 2007/2008 Budget at J$71 to US$1.

As to inflation and the exchange rate. Table 1 shows that the relative purchasing power parity (PPP) theory has almost perfectly predicted the movement of the Jamaican dollar since 1997, Bank of Jamaica Governor Derick Latibeaudiere's first full year in office.

Now, Dr. Davies' arguments about 'one-off natural shocks' surely cannot apply to an 11-year period where the average Jamaican inflation rate was 9.3 per cent compared to 2.5 per cent in the U.S. Assuming that its objectives have been consistently achieved, the question of why the BoJ would set such a high long-term target rate is one only Governor Latibeaudiere can answer. Both he and Dr. Davies must have been aware of the inevitable effect, namely, an average depreciation of the Jamaican dollar of 6.8 per cent per year against its U.S. counterpart.

These numbers suggest that the J$-US$ exchange rate is largely driven by price movement differentials, i.e., the gap between U.S. and Jamaican inflation rates.

The significant exception was in 2003-2004, when the value of the Jamaican dollar in U.S. terms was up to 11 per cent lower than relative PPP would have predicted, i.e., the J$ was 11 per cent under-valued. Then the dollar movement was likely driven by expectations of significantly increased inflation, triggered in part by Dr. Davies' famous 'We run wid it, Comrades!' statements regarding the fiscal loosening that preceded the 2002 election. This remains a cautionary 'loose lips sink ships' tale of the potential negative impacts of careless rhetoric by public officials.

Here was a classic instance of the intangible 'confidence factor' coming into effect. For despite a situation where inflation was under control - single digits for six straight years, an absence of 'confidence' in macroeconomic management caused holders of wealth to choose to shift resources and demand foreign exchange while surrendering their Jamaican dollars. Which inevitably led to a depreciation of the Jamaican currency.

When a finance minister publicly admits that financial prudence has been sacrificed on th of vote-buying expediency, well, even school- children expect inflation to increase sharply. And such was indeed the case. Inflation almost doubled from 7.3 per cent in 2002 to 14.1 per cent in 2003, and did not return to single digits until three years later. But the exchange rate mostly corrected itself by the end of 2004, and since then has scarcely deviated from relative PPP predictions.

The JLP administration that came to power in September could only have had a minimal effect on the overall 2007 inflation rate. The evidence therefore suggests that those who sought to blame the new government for post-election exchange rate movements were being either ingenuous or wilfully ignorant.

Dr. Davies also counters my criticisms of Governor Latibeaudiere's stewardship in terms of the inflation out-turn in Jamaica versus our major trading partners. Well, here is a 2006 CIA World Factbook ranking of countries by inflation rate. These numbers make it obvious that from an international perspective Jamaica's record is quite poor, especially when compared to our fellow West Indian islands, who face the same global economic challenges as us.

I. Zimbabwe 585.00

2 Iraq 40.00

3 Guinea 25.00

3 Burma 25.00

4 Zambia 19.00

5 Angola 17.70

6 Afghanistan 16.30

7 Iran 16.00

9 Nigeria 15.60

10 Serbia/Montenegro 15.50

17 Jamaica 12.90

44 Trinidad and Tobago 6.80

61 Dominican Republic 4.30

72 United States 3.20

74 Saint Lucia 3.00

76 Grenada 2.80

76 Cayman Islands 2.80

82 United Kingdom 2.20

82 European Union 2.20

82 Canada 2.20

92 The Bahamas 1.20

96 Antigua and Barbuda 0.40

100 Barbados 0.50

I have nothing personal against Governor Latibeaudiere or Dr. Davies. In fact, I have spoken and written in the past of my admiration for the former finance minister's willingness to make tough decisions and say it like it is. Though, of course, given Jamaica's mediocre economic performance since 1993, this approbation could hardly be unqualified.

What seems easy in theory is not always so in practice. Few things are more annoying than self-righteous spectators in the pavilion, who have never faced bouncers themselves, lambasting batsmen for playing incorrect strokes. But as Deng Xiaoping said, we must seek truth from facts.

Table I

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 AVG


  • Ja inflation -9.2 7.9 6.8 6.1 8.8 7.3 14.1 13.7 12.9 5.8 10(est) 9.3


  • US inflation - 2.3 1.6 2.2 3.4 2.8 1.6 2.3 2.7 3.4 3.2 4.1 2.5


  • US$ projected - 38.15 40.53 42.36 43.47 46.00 48.58 54.20 60.02 65.54 67.17 70.94


  • US$ actual - 36.36 37.29 41.27 45.48 47.36 50.18 60.61 61.85 64.67 67.02 71.18

    Difference- 5% 9% 3% -4% -3% -3% -11% -3% 1% 0% 0%

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