derick latibeaudiere : the effect of oil prices – the case of the importers presentation by mr derick latibeaudiere, governor of the bank of jamaica, at a round - table discussion during the meeting of latin american network of central banks and finance ministries, washington dc, 19 - 20 october 2006. * * * the sustained increase in oil prices since 2002 has been of tremendous concern to us in jamaica, and it is with a great deal of relief that we welcome the most recent indications of a reversal of the trend. the increases in oil prices since 2002 has been the most ‘ shocking ’ since the first major oil price jolt in the early 1970s - much beyond anything that we had anticipated. the situation in jamaica in the 1970s was much different from what it is today. back then, there were significant structural weaknesses in the economy, which greatly increased the country ’ s vulnerability to external shocks. the impact of the 1973 oil shock uncovered some of those weaknesses and made the situation much more difficult to manage. indeed, the difficulties that we experienced following the 1973 oil shock contributed to jamaica ’ s first borrowing experience with the imf and were to a large extent responsible for the significant increase in inflation that continued to endanger our economy for the next two decades. things have changed since that time. the jamaican economy has undergone significant structural and other changes and the macroeconomic fundamentals are now much better. inflation has moderated and is now much less inimical to our economy. in addition the central bank has built a reasonable reserve cushion to help us deal with shocks of this nature. notwithstanding this, jamaica like most other oil importing countries has felt the adverse effects of the persistent increases in oil prices. this has been particularly noticeable at the pumps and in our electricity rates. but despite the cumulative negative impact, the economy has remained relatively buoyant over the last two years. it is indeed true that some of the very factors that influenced the sustained increases in oil prices were also the factors that contributed to the increased investment, the growth in tourism and the demand for bauxite that jamaica has been experiencing. these factors relate to the acceleration in world economic growth and the demand for commodities including oil, which contributed to the sharp increases in oil prices over the last four years. for me the real concern is the effect that the increases in oil price has on inflation and also on the balance of payments. the price of oil has risen on an annual average basis by approximately 20.

0 per cent between 2002 and 2005 - significantly higher than the annual average increase of 12. 0 per cent between 1998 and 2001 and much more than the increases that we experienced in the 1980s and early 1990s. increases in oil prices have a direct impact on inflation. the price of crude oil immediately impacts electricity and gasoline. in jamaica, electricity prices are not subsidized and therefore increases in the price of oil are passed directly to the consumer via a tariff formula that immediately adjusts the electricity rates. transportation accounts for the largest proportion of refined fuel sales by the domestic refinery. the consumer basket measured by the cpi only includes public transportation, ( bus fares ) and therefore a large segment of the major gasoline consumers are not included in the cpi. bus fares are also administratively determined and implemented with a lag. therefore the changes in oil prices are fed through to the cpi more slowly. in the case of cooking gas and related products these items carry relatively small weights in the jamaican consumer basket. consequently, although the prices are adjusted in line with the increases in external oil prices, the impact on inflation has been correspondingly small. this brings me to the impact of the increases in oil price on measured inflation in jamaica. for the four fiscal years prior the start of the oil shock, domestic inflation averaged approximately 8. 0 per cent per year. for the four years after the oil shock, inflation accelerated to an average of 14. 0 per cent per year. an examination of the trend in jamaica ’ s inflation could, a priori, suggest that the acceleration in jamaica ’ s inflation was a result of the oil shock. the evidence shows, however, that the increase in inflation over this period was related more to increases in food prices than to increases in energy related prices. the economy suffered a range of weather related shocks that caused food prices to increase significantly over this period. therefore, the dramatic increase in oil prices was not the main factor contributing to the increase in jamaica ’ s inflation for that period. the effect of the sustained increase in oil prices would, however, have directly impacted those persons in the higher income groups who would not be included in the cpi. the increases in the price of oil were felt most acutely in jamaica ’ s current account. the cost of fuel imports jumped from 6. 7 per cent of gdp in fy2001 / 02 to about 15. 0 per cent in fy2005 / 06. in this context, the deficit moved from a sustainable average of 5.