One of central banks’ key roles is maintaining price stability. This usually means a stable and predictable rate of inflation. Authorities care about the rate of inflation because out of control inflation can cause several problems including erosion of purchasing power, uncertainty of investments for businesses and households, increasing vulnerability of pensioners and others on fixed incomes, higher union demands, less competitive exports and a greater need for the government to spend (often borrow) on social protection programs. To control the rate of inflation, central banks will utilize the tools at their discretion. The use of these tools is what economists call Monetary Policy.
The tools available to central banks can broadly be categorized into two groups, direct and indirect. Direct tools are reserve requirements, direct credit control, direct interest rate control and direct lending. Indirect tools are open market operations (OMOs, the buying and selling of government securities), interbank lending rates and repo rates. The general idea behind direct tools is to increase/decrease the money supply, increase/decrease interest rates, or both. The general idea behind indirect tools is to influence banks to act in a way that achieves a similar result, that is, an increase/decrease in the money supply, an increase/decrease in interest rates, or both. Economist will often talk about monetary policy transmission, which is how successful the tools are in getting banks and the overall economy to positively respond to the central bank’s direction. The selection of a tool or a sub-set of tools is partially dependent on the transmission mechanism.
The regional inflation rate rose to 9.6% in 2022 from 3.0% in 2020 and 6.7% in 2021, and in some regional countries such as Suriname and Jamaica, 2022’s inflation was as high as 52.4% and 10.3% respectively. What’s more, the expectation at the time was that inflation would stick around for a while. Indeed, that turned out to be true as inflation remained stubbornly high in 2023, averaging 7.9% for the region and as high as 51.6% in Suriname and 6.5% in Jamaica. Such inflation required central banks to respond. The common prescription is for central banks to raise interest rates, as was done in the USA, Eurozone and UK, but not all regional central banks raised rates, in fact, Jamaica was the lone major regional economy to do so, though effective August 21st 2024, their policy interest rate was reduced by 25 basis points to 6.75% in response to inflation now comfortably within the Bank of Jamaica (BOJ) target of 4-6%. The other regional economies (Trinidad and Tobago, Barbados, the Organization of Eastern Caribbean States (OECS) and Guyana) kept rates steady. Why?
While central banks try to manage inflation, they have to be wary of being disruptive to economic growth. Raising interest rates tends to cool off economic activity since the cost of borrowing and investing becomes more prohibitive. Additionally, if the central bank raises its policy rate, but banks are flushed with liquidity (essentially, a high level of deposits versus loans) then the monetary policy transmission mechanism will be weak and interest rates in general could remain stagnant or even decline! Central banks in such an economy may choose to use another policy tool such as increasing the reserve requirement (essentially, reducing the amount of liquidity) causing a tightening on credit activity through a lowering of the supply of loans and therefore higher borrowing rates. A further reason for some regional policy interest rates’ immobility could be the extent of capital controls. As the USA and other countries raised their interest rates, the attractiveness of money or capital flowing to those countries is increased unless the domestic economy also responds with rate hikes. However, if foreign currency cannot easily leave a country, such as in Barbados, Trinidad and Tobago and the OECS because of fixed or managed exchange rates and/or availability of foreign exchange, then the pressure to raise domestic interest rates in response is much smaller.
Instead of interest rate adjustments, Trinidad and Tobago, Barbados, Guyana, Suriname and the OECS relied more heavily on fiscal policy and alternative monetary policy tools such as the reserve requirement and OMOs. It is not a one size fit all or use of a single tool when it comes to monetary policy and each central bank would use what is appropriate to its main objectives and conditions at the time.
Regional inflation is expected to decline to average 4.3% in 2024 and 3.6% in 2025. Jamaica and Suriname are expected to see material disinflation over the two years. Achieving the end result of price stability is what matters.