From: mcbean@vax.oxford.ac.uk
Newsgroups: soc.culture.caribbean
Subject: Dynamics of our High Inflation (Jamaica)
Date: 7 Oct 92 11:13:51 GMT
Organization: Oxford University VAX 6620

Reprinted from the Sunday Gleaner (Jamaican Sunday paper) of 27/09.  Done
without permission.  The author is Michael Tharkur, a Senior Economist at the
Private Sector Organisation of Jamaica.




/*------------Dynamics of our high inflation------------*/


This article seeks to identify the main causes of the unprecedented consumer
price increases in 1991 to early 1992, and to advance some perspective on the
policy implications of these developments.  The Jamaican economy can be
considered open with significant deregulation of the internal markets for
goods, the market for loanable funds, the labour market and the market for
foreign exchange.

Within this "liberalised" economic framework, monetary control becomes the main
policy lever of government's stabilisation programme, and by implication, the
primary means of controlling inflationary impulses in the economy.  

In order to facilitate macroeconomic stabilisation through tight monetary
control, howefer, it is important that the sources of monetary expansion be
identifiable, and be responsive to policy instruments.  During 1991, a major
source of monetary expansion in the Jamaican economy was the increase in base
money  which occured primarily as a consequence of involuntary net credit
expansion by the Bank of Jamaica to the public sector.

This arose in part from fiscal patterns of expenditure unsustained by revenue
inflows, thereby creating interim deficit financing by the Bank of Jamaica. 
While such financing was allowed to accumulate, the Bank of Jamaica issued
securities at increasingly higher rates of interests in attempts to retain its
hold on the money supply.  The inability of the Bank of Jamaica to effectively
sterilise the net injection of liquidity from de facto fiscal looseness, became
a significant factor which exacerbated the initial inflationary impulses during
1991 to early 1992.

/* Loss of Confidence */

Higher prices were initiated during 1991 from planned deregulation of food
prices, implementation of the General Consumption Tax, and breakdown of the
foreign exchange rate system prior to the floating system implemented in
September 1991.  These initial impulses were, however, intensified by the
interplay of several factors at different times during the year.  Firstly,
goverment's overall borrowing requirements exceeded programmed targets by
mid-year.

This generated net injections of liquidity into the banking system which
coincided with reductions in interest rates by government (ostensibly to
stimulate investment), and fixing of the exchange rate by commercial banks. 
Inflation peaked in June at 10.2 percent due to the combination of further
deregulation of food prices and the emerging speculation in the foreign
exchange market facilitated by the above conducive environment.

By the end of July, the fixed rate of exchange by the commercial banks became
evidently unsustainable.  Betweeen July and September, the rate of exchange
depreciated rapidly as inflationary expectations increased and loss of
confidence in the Jamaican currency grew.

In an effort to eliminate the mounting loss of confidence in the domestic
currency during the latter half of 1991, the government brought forward its
scheduled full liberalisation of the foreign exchange regime in late September.

Whilst this served to slow the pace of depreciation of the Jamaican dollar
during the last quarter, continued growth of net credit to the public sector
for most of the quarter, coupled with seasonally high impact demand, fuelled
further domestic inflation.  To prevent even greater inflation pressures,
government withdrew from the foreign exchange market and drew down instead on
its international reserves.

At the end of 1991 therefore, inflation out-turn which averaged 51.0 percent,
reflected the interaction of multiple influences throughout the year.  The
discussion, however, revealed that while the proximate causes of inflation in
1991 included exchange rate depreciation, excess growth in money supply, and
further planned adjustment reforms; the fundamental influence from monetisation
of public sector  borrowings as a sustaining element cannot be overlooked.

Data for January to July of 1992 indicate that high rates of growth in consumer
prices persisted into the first four months despite some indications of
restraint of net public sector borrowing and slow-down in the growth of money
supply.  The exchange rate remained relatively stable in the first two months,
following which speculatory pressures emerged in April relating to the
selection of PNP leader and eventual Prime Minister.  Subsequent to the Butch
Stewart initiative in April, consumer price increases have slowed markedly in
tandem with the stability in the exchange rate, and greater efforts to observe
fiscal discipline.

/*--Social Contract--*/

The record inflation experience of 1991 to early 1992, has generated some
concerns by government that labour demands to compensate for erosion of real
incomes in 1991, could significantly fuel further inflation pressures in 1992
to 1993.  This has led to the proposed establishment of a "Social Contract"
between trade unions, private sector and government to temper anticipated
excessive wage/salary demands.  While the policymakers' fear may be real for
certain cases, in the main, the present economic context and past empirical
evidence suggests an overreaction on the part of the government.

Theoretically, wage demands are inflationary to the extent that the higher cost
of production is unparalleled by productivity improvements, and the full
increase in cost is passed on to the consumer.  For export economic activities,
upper limit on wage/salaries will be fixed by the price of competing exports in
the target market.  In the case of import substitution production, in an open
economy such as Jamaica, upper limit of wages/salaries will be fixed by the
price of the direct imported alternative (including custom duties).  Rising
labour costs may also encourage the adoption of more capital-intensive
techniques of production which raise the productivity of labour.

Notwithstanding the above requirements, wage costs inflation could be
significant depending on the degree of monopoly power which exists in the
labour market.  In the non-tradeable sectors, for example the public utilities,
which enjoy monopoly status, excessive wage demands could generate significant
inflationary ripples.  The solution however does not lie in agreements which
may repress the labour market.  Rather, effective supervision of such public
monopoly institutions to ensure that efficiency is maximised, may be a
preferrable alternative.

A social contract which sets wage limits in leading sectors controlled by
unions, may also undermine further structural shifts in production consistent
with Jamaica's comparative cost advantages.  If light monetary policy is
maintained with realistic growth targets, then potentially inflationary impact
from excessive wage demands could be sterilised by fiscal measures.


/*------------End of article----------------*/