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Sunday, March 14, 2010

The Caribbean needs a strategy for fighting inflation!

Trinidad and Jamaica have been plagued by the persistent scourge of high inflation and, subsequently, the high price of goods and sevices.

Less pronounced is the creeping inflation in The Bahamas- this is the steady and consistent rise in prices between 1 and 6 percent, to which there hasn’t been a deflationary session, to bring prices back under the point from where they began their incline.

Inflation matters, for all the right reasons. Governments through macroeconomic policy and central banks through prudentially active monetary policy should continually be cognizant of inflation. In fact, one should not just monitor inflation- you should fight it.

Inflation has two direct causes- demand pull and cost push. The former is caused as a result of increased demand, with shrinking, or, weak supply- law of supply and demand, lower supply raises the price and vice versa, in "most" cases. The latter, is as a result of the rise in cost of the factors that produce goods and services- for example, the rise in the price of crude oil, due to the machine parts that are used to drill crude, or, the rise in education costs, which affects the price of service related jobs.

Let's examine the price levels in the three countries mentioned- Jamaica, Trinidad and The Bahamas. Here is the IMF's statistics on average and average end of period consumer prices between 2003 and 2011- projected from 2009 and beyond:

Jamaica- the country with the highest inflation- has a considerable challenge with managing inflation and currency value, even before the inflationary spike between 2007 and 2008.

Throughout the 80's and 90's, the Jamaican Central Bank has been, unfairly, commented on as being a printing press, rather than a place were monetary policy complements economic growth through the stabilizing prices. But instead, the trade off has been towards creating employment and financing public sector projects.

Even more so, higher wage demands have been a consequence along with the need for higher salaried job creation in the public sector- which is part of the failing of macroeconomic policy on one side, coupled with a lack of assertiveness of monetary policy makers, on the other.

Trinidad has been on a high inflationary course, since their oil boom. Trinidad has also been reluctant in revaluing the Trinidadian dollar. This is as a result of the need for the Trinidadian government to assist with expanding their export potential in oil and other light manufacturing.

This causes higher than needed inflation in Trinidad, by having, on the one hand, a need for increasing money supply to fund employment and higher, nominal wage levels. On the other hand, Trinidad’s need to keep export industry prices low, in order to maintain production and keep relative prices for export competing goods, competitive, also influences policy decisions.

The Bahamas in slight contrast, as with the case for Jamaica, Trinidad and most other Caribbean countries, has an ongoing problem with positively sustaining the effects of external supply shocks.

Take for example the impact that oil has on the global market. The current price makers for crude oil are all denominated in US dollars- which can be described loosely as the “petrodollar”. The two major oil bourses are the New York Mercantile Exchange (NYMEX) in New York City and the IntercontinentalExchange (ICE) in London & Atlanta, which are housed between the USA and the U.K.

This means that as the US cuts interest rates, oil is affected in a substantial way: an increase in US dollars in the market to trade, will increase oil speculation. In addition, the TARP programme administered by the American government to support financial institutions, both commercial and investment, have sustained both short term lending and trading activity and added fuel to the fire- so to speak.

These financial firms ran away from mortgage related lending and trading, and instead found havens in the oil and metals markets and, that speculation, elevated price levels artificially as the activity, was as a response to investor/institution appetite to sustain returns, even during the current economic crisis.

In fact, the huge spike in crude oil prices at the end of 2007 through 2008 can be directly correlated to the lowering of the rates on the US dollar, coupled with the investment in large financials in the US through TARP.

When we examine both the fluctuations of interest rate reductions and crude oil price levels, we see a strong correlation and a co-movement of both variables and further relationships with three variables, when we factor in the weighted roll out of the TARP funding schema as an additional variable.

In light of this, I feel that it is clear that the region needs a committed and coordinated plan to contain and fight inflation. The cost to businesses and households, demands that a comprehensive strategy be put in place to mitigate some of the more harmful effects of external supply shocks on regional inflationary pressure.

One thing can be too simultaneously revalue currencies up by 10% of the band, especially in the case for Trinidad and The Bahamas, while, perhaps, cutting the rates by25 bps at the very least. This would strengthen purchasing power, while at the same time increasing the money supply in order for it to compete for goods, relatively, with other regions.

The only issues would be with regard to fixed exchange rate ineffectiveness, in addition to causing a run on foreign reserves. However, it would ease domestic inflation by creating money supply and spurring activity while strengthening purchasing power, during this still yet current crisis.

To go even further, tariffs on consumer goods should be relaxed in order to allow for businesses to take advantage of import competing goods at a relative cheaper rate. In addition, this will attract currency traders by creating speculation and spurring demand for the dollar as well as attract foreign direct investment, by increasing the capacity to develop without high inflationary costs -if conventional wisdom on currency revaluation dictates otherwise.

A longer term external supply shock plan must be put into the regional discussion as a way to combat inflation uncertainty in the long term. A plan that involves increasing capacity in food security, oil reserve maintenance and coordinated Central Bank policy that entails- where appropriate- a pegged exchange rate version of inflation targeting, foreign reserve and petrodollar risk sharing and management in addition to maintaining upward stability when US interest rates rise.
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