Tightened too much
Economist fears BOJ may have increased rates too much so far, urges caution
THERE are fears that the Bank of Jamaica (BOJ) may have increased its key policy rate too fast over the last year and that the action could present a real risk to continued economic growth and job creation.
The BOJ’S key policy rate is used as a signal to the market of the direction it wants interest rates in the economy to go to achieve its stated aim. In this case the central bank has increased interest rates eight times in the last year to a near 10-year high of 6 per cent to rein in inflation that has floated away like a helium balloon.
But financial economist Dr Adrian Stokes believes the rate hikes are pushing the economy to the brink, especially given what he labels, “a sluggish recovery” from the pandemic-induced economic downturn.
“Absolutely, there is no doubt in my mind that they have [tightened too much]...if they expect the Jamaican economy to return to peak only in 2023,” Stokes told the Jamaica Observer in a statement which clarified exactly what he meant when he said, “The recovery has been sluggish.”
“If they are suggesting for the economy to get back to its peak in 2023, that means we have had a fairly sluggish recovery from the trough created by COVID, and, again, recall that monetary policy impacts with a lag,” he added.
Despite interest rate hikes, the economy expanded by 8.2 per cent in the 2021/2022 fiscal year, which ended this past March, and is projected to grow in a range of 2.5 per cent to 4.5 per cent during this fiscal year before slowing further to 1 per cent to 3 per cent growth in the 2023/2024 fiscal year.
The BOJ, for its part, forecast that the economy will only return to PRE-COVID-19 levels “in early 2023”.
But Stokes warns that interest rate hikes so far could scupper that expectation.
“The big risk is that when the Bank of Jamaica’s monetary policies are to take full effect and that, if coupled with the slowdown in the US economy, the question is: Will our economy be able to withstand those two forces? And so I believe the big risk right now is the risk to growth,” he argued.
The Bank of Jamaica says it takes between 4 to 8 quarters (about 1 to 2 years) for the full impact of its monetary policy actions to take effect in the economy. That would mean the rate hike, which was first announced last year at this time, is just taking hold in the economy. To counter that lag, the central bank said it has made its monetary policy action “forward-looking”, which could explain why it moved early and aggressively with interest rate increases.
Stokes, however, outlined that with the Federal Reserve — the US central bank — signalling that its rate increases designed to slow the US economy could tip it into a recession, the “knockon effect to the rest of the world and Jamaica in particular” could be devastating, especially with the full impact of the more recent BOJ rate increases still to come.
“There is going to be some slowdown, which hasn’t started as yet because the full effect of the transmission mechanism takes some time. But we have started to see banks and other financial intermediaries passing through tighter monetary conditions. Financial conditions have tightened and so on. The construction sector looks like it has slowed to a crawl. And so you can begin to forecast what will happen when this 550 basis points of increase [since October last year] starts to really hit, and the fear is that it will happen at a time when the US economy is also slowing, and then you have this double wammy of a slowing US economy and a slowing Jamaican economy because of the interest rates, and the question would then be: Has the BOJ tightened too much and how fast will they have to reverse policy [to counter the economic slowdown]?”
While Stokes expressed that fear, NCB Capital Markets, an investment bank, has already forecast that rates could be hiked by a further 0.25 per cent to 6.25 per cent. However, the BOJ has signalled that at 6 per cent, its policy rate is close to an “appropriate level”, adding in the notes accompanying its last monetary policy decision that it is prepared to pause the rate increases “if the incoming data continue to reflect a downward track for inflation”.
But for Stokes who also chairs the economic policy committee of the Private Sector Organisation of Jamaica, that could be too late. Besides, he thinks lower inflation rates (10.9 per cent in May and June and 10.2 per cent in July and August), since the peak in April at 11.8 per cent, were achieved, inspite of the BOJ’S actions.
“I think, given the aesthetic slowdown in the global economy and the US economy in particular, it is clear that inflation will come down. Here in Jamaica we have started to see that. It has nothing to do with Bank of Jamaica policy. If you look at the inflation out-turn and what has been driving it, its due almost entirely to commodity prices and prices are moderating and we are getting that pass through in Jamaica. And that will continue. In fact, it could speed up, given the expected fall off in [global] growth.”
The International Monetary Fund forecasts global growth to slow from 6.1 per cent last year to 3.2 per cent in 2022, 0.4 percentage point lower than in the April 2022 World Economic Outlook. Slower growth typically means lower demand, which will help to cool prices, especially for commodity prices, such as for oil and grains.
“The risk in Jamaica is not high inflation or inflation getting higher, the risk is slower growth,” Stokes told the Business Observer.
Because of that risk, central bankers typically move slowly. That’s because their policy tools are blunt and work with a lag, meaning interest rate increases will need months to filter out across the economy and take full effect. And the impact is uncertain. Jerome H Powell, the Fed chair, once likened policymaking to walking through a furnished room with the lights off: “You go slowly to avoid a painful outcome.”
But, from Washington to Jakarta, central banks are hiking rates to combat inflation. For Stokes, who was the first to publicly criticise the BOJ’S rate increases, the causes of inflation in Jamaica is different from the causes in other countries, and so the response must be different.
“The fact of the matter is inflation in the US is being driven by an economy that is overheating.
In other words, it’s caused by significant demand for goods and services in the US economy, largely led by significant stimulus by the US Government and to curtail that you require demand management policies, aka, tighter monetary policy, which is what the Fed is doing because their inflation is largely driven by demand conditions, and then you have some supply constraints which created a problem. Supply constraints are easing, but because of the surge in demand in that economy, higher interest rates are needed.
“In Jamaica’s case, our inflation, as we have said before, is not driven by surge in demand. Inflation was largely driven by supply constraint and so, therefore, the solution is not to curtail demand in an economy that is still recovering.”
“It seems almost counter-intuitive to be reducing demand in an economy that is still below its 2019 peak.”
His concern echoes those of economists in the US who worry that the aggressiveness of the monetary policy action now underway is pushing central banks into new and risky territory. By tightening quickly and simultaneously when growth in the US, China, and Europe is already slowing and supply chain pressures are easing, the concern is that central banks risk overdoing it and may plunge economies into recessions that are deeper than necessary to curb inflation, sending unemployment significantly higher.
As the major monetary authorities lift borrowing costs, their trading partners are following suit, in some cases to avoid big moves in their currencies that could push up local import prices or cause financial instability.
Already, the moves are beginning to have an impact. Climbing interest rates are making it more expensive to borrow money to buy a car or a house. But the Bank of Jamaica said the increases were below projections, indicating a weak response to the BOJ’S policy rate adjustments so far.
Yet the full effect could take months or even years to be felt.