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Jamaica’s inflation targets, set in September 2017, are for a minimum of 4.0 to a maximum of 6.0 percent. The country must achieve these targets for inflation within 3 to 5 years. Nearly two years in, Jamaica’s actual inflation is 2.4 percent, well below Jamaica’s minimum target of 4.0 percent. While this low inflation is good news for consumers, is it really good for business?
BOJ Monitors Jamaica’s Inflation Targets
In essence, Jamaica’s targets for inflation are significant steps in its Economic Reform Programme. Also, the BOJ and the Ministry of Finance continuously measure these targets over the medium term. Furthermore, this way of setting and managing inflation targets is a more effective strategy than the usual fiscal year inflation targeting.
Within the continuous inflation target regime, the Finance Minister evaluates the Bank of Jamaica (BOJ) on Jamaica’s inflation rate. This evaluation is done at any time rather than at the end of a financial year. Plus, the Finance Minister may adjust monetary policies to meet the challenges or opportunities presented by Jamaica’s current economic conditions.
The BOJ manages the economy’s inflation performance through the adjusted money supply and interest rates.
What is inflation?
The Statistical Institute of Jamaica (STATIN) defines inflation as
“the overall general upward movement of the prices of goods and services in an economy.”
This definition means under high inflation conditions, marked by higher prices; consumers buy fewer goods and services with a fixed sum of money. Conversely, when inflation is low, characterized by lower prices, consumers buy more with the same amount.
State of inflation
Over the past 30 years, Jamaica experienced persistently high inflation, high-interest rates, and significant currency devaluation. However, since 2006 Jamaica’s inflation rate has fluctuated. But over the last three years to 2018, inflation dipped to its lowest level of 2.4 percent. Consequently, the island’s economy saw little growth during much of the period.
To counteract the runaway inflation of the past, the GOJ gradually introduced economic reforms that result in stable, predictable, and low inflation.
BOJ’s Options to Address Inflation
In response to the lower than targeted inflation rate currently being experienced, the BOJ has the option to increase interest rates. As expected, this action will slow down loan growth and reduce the demand for loans. With that policy in place, inflation would naturally rise to the desired level of 5 percent.
Unfortunately, this adjustment in policy goes against the broader policy aim of promoting conditions that allow economic growth and job creation. For the GOJ, managing inflation performance to within desired levels while stimulating economic growth is a delicate balancing act.
The GOJ prefers to achieve inflation targets within 5 percent over at least a three-year period. Given Jamaica’s history of persistently high-interest rates, the relatively lower inflation of 5 percent would represent a strategic balance that allows the economy to grow without discomfort to both consumers (who would enjoy relatively lower prices), and producers (who will enjoy lower interest on loans).
How inflation targets affect small businesses
The BOJ projects that within 3 to 5 years Jamaica would attain an inflation rate of 5 percent. This expected movement toward inflation targets allows the central bank to maintain low policy interest rates that will be attractive to clients of lending institutions. Buoyed by low-interest loans, businesses will secure more capital and, through renewed economic activity, create more employment. The economy would grow as a result.
Notably, lower inflation leads to higher real interest rates which influence investment decisions. Hence, if the inflation target were 3 percent (which is around current levels), higher market interest rate on loans or money instruments would result. Investors would then place their money in liquid assets like bonds and certificates of deposit, rather than risk investing in a productive business enterprise.
The Government of Jamaica desires more investment in the productive and business sectors. So, it actively promoted entrepreneurship and job creation as part of its economic reform policies.
The impetus behind the current inflation of 2.4 percent is the drop in agricultural prices and the significant fall in international oil prices. For consumers, this is good news as their money will pay for more produce and fuel at constant prices. For business enterprises and investors in the productive sectors, the cost of capital (loans) would be higher if the BOJ’s high-interest rate policy kicks in.
Medium, Small, and Micro Enterprises (MSMEs) would find it challenging to afford capital at higher interest costs. Currently, small businesses face the prospect of higher interest charges for any funds they wish to raise.
BOJ Lowers Policy Interest Rates
A release from the Bank of Jamaica said, “The economy needs a level of inflation that is neither too high nor too low. An inflation rate of between 4.0 percent and 6.0 percent is judged to be appropriate for Jamaica at this time to ensure a range of desired economic outcomes. A lower inflation rate may be associated with weakness in the economy.”
The current inflation rate of less than 3 percent is too low to enable active economic growth. In response, the Bank of Jamaica, on 20 December 2018, reduced the policy interest rate offered on overnight deposits at BOJ by 25 basis points to 1.75 percent. Financial institutions like commercial banks and building societies are expected to pass on the lower rate to their clients so that economic activity will increase.
Small businesses will benefit from this strategic move by the BOJ.