Which to watch? Inflation vs exchange rate

BY KELLARAY MILES, Jamaica Observer

he Bank of Jamaica (BOJ) and the Government, as a part of the country’s monetary policy direction, have taken the decision to focus on inflation targeting instead of foreign exchange (FX) movement.

This approach is deemed more prudent as inflation targeting focuses more on domestic considerations which are better able to respond to shocks in the market. This is not possible under an exchange rate system.

The exchange rate system looks at just one price of one currency in comparison to another, while the inflation rate is the cost price of many goods consumed by citizens grouped together in a basket.

Noting that inflation affects everyone directly, government and economic experts have thought it wise to track and give key focus to this measure.

They are of the view that while many Jamaicans tend to see health of the economy as integral to the dollar’s value, this should not be the case as inflation targeting is a better measure as the repercussions are more direct. Through its inflation targeting framework, the central bank has opted to track, monitor and maintain low and stable inflation within its prescribed medium range of 4.0 per cent – 6.0 per cent.

Prime Minister Andrew Holness recently reiterated the Government’s position in support of inflation targeting over foreign exchange.

Given the volatile movement of the Jamaican dollar within the last couple of days, the prime minster has sought to comfort the fears of many Jamaicans who have become concerned about the sporadic depreciation of the Jamaican dollar.

The Business Observer in its quest to get a general view on what is the belief of some stakeholders regarding both has sought to find out which is a better measure.

The comments are cited below:

Keith Duncan- President of the Private Sector Organisation of Jamaica (PSOJ)

“Inflation is the index that at the end of the day records movement in price levels and impacts purchasing power – and this is where we need to focus. Movement of the exchange rate will show up in the inflation numbers. As such, extreme volatility in the exchange rate which creates disorderly market conditions should be minimised.”

Dr Andre Haughton- Lecturer in Economics at the University of the West Indies (UWI)

“In a small island developing state that operates an open economy, the exchange rate is as important as inflation in determining the overall cost that is borne by the economic agents of a country. Whenever the exchange rate depreciates by a per cent, our national debt also increases by 0.5 of a per cent. Therefore the debt has an impact on 1. Government and 2. Businesses; as when they purchase goods from abroad or any type of equipment this has an impact on the overall expenditure and therefore when they use these goods to produce other goods they will be more expensive or even if they are buying goods to resell then these become more expensive also for the consumer.

So the exchange rate is an important factor in determining the overall cost burden on consumption, not just of household items, but for durables and input as well. More importantly it has an implication for the country’s national debt.”