Tweet
LETTER OF THE DAY: Omar on budget construction
published: Sunday | January 13, 2008
THE EDITOR, Sir:
Your columnist, Kevin O'Brien Chang, in his wide-ranging piece on Sunday, January 6, sought to contribute to the debate on the exchange rate assumption which was made by the Ministry of Finance, in constructing the 2007/2008 fiscal budget.
He argues that by assuming a rate of J$71 to the U.S. dollar, as indicated by Prime Minister Golding in Parliament, the past administration would have known that inflation would have been at a double-digit rate, rather than the six-eight per cent range which was announced in the economic programme. The clear implication of his assertion is that the administration in general, and I, in particular, had deliberately misled the country in this matter.
He bases the assertion of "prior knowledge" by appealing to the "relative purchasing power parity theory" which he argues, has accurately tracked the value of the Jamaica dollar vs the U.S. dollar over the past three years. He goes on to criticise "some media persons and politicians" for failure to understand the real relationship between inflation and the exchange rate.
I welcome Mr. Chang's contribution to the discussion. However, I respectfully suggest that his piece reflects a less-than-complete comprehension of the complexity of the issues which must be taken into consideration in (i) analysing the casual factors affecting inflation in Jamaica; (ii) defining the relationship between inflation and exchange rate; and, (iii) in preparing the Estimates of Expenditure for a fiscal year.
exchange rate
Let me begin with the matter of the construction of the Estimates of Expenditure. Given that these estimates are denominated in Jamaican dollars, an assumption has to be made about the rate of exchange at which external obligations - in particular debt - will be settled during the fiscal year.
The technicians at the Ministry of Finance have developed the practice of using a rate of exchange which minimises the level of additional dollars needed even if the exchange rate moves against the projected trend. Put another way, it is far more desirable from the budget's point of view, to have overprovided Jamaican dollars for settling external obligations than to have underprovided. Any such under- provision will logically imply including additional resources to be included in the Supplementary Estimates.
We do not have to look very far for concrete examples of the conceptual point mentioned above. In the Supplementary Estimates which were recently approved by Parliament, there are several examples under Head 201A (Interest Payments) as well as under Head 2000A, where there are additional requirements resulting from the fact that the exchange rate has moved beyond that which had been projected.
I would recommend that Mr. Chang, as well as any other persons interested in the topic, peruse the document and see the point which I am making.
I now turn to the issue of Mr. Chang's assertion that the Govern-ment must have known in advance that it would not have been possible to attain single-digit inflation. Clearly, the fact that there are now additional requirements for external debt servicing indicates that even if Mr. Chang's assertion were correct, the present administration has now overshot the projected exchange rate.
However, there is a more substantive point to be made about the ability to project an inflation rate, which Mr. Chang has not fully grasped. In fact, it is related to a criticism he has made of the stewardship of Governor Latibeaudiere in terms of the inflation outturn in Jamaica vs our major trading partners.
In layman's terms, one can differentiate between 'core inflation' and 'headline inflation'. Core inflation is mainly related to the expansion in money supply.
'headline' inflation
We can contrast this with 'headline' inflation', which then takes into consideration price movements which are either due to one-off actions or are due to developments totally out of control of local authorities, e.g. movements in the prices of critical inputs of price movements related to the vagaries of mother nature. In those instances, it is impossible for anyone to project what increases will result and as such, these are not subject to control by policymakers.
In Jamaica's case, we face an interesting policy dilemma specifically as it relates to support for domestic agriculture. Given the weighting of food in the CPI basket and further given the importance of domestic food production/consumption in our national economy, any major shortage in domestic food output invariably translates into higher prices with a significant impact on the overall CPI basket.
This is particularly so in Jamaica as opposed to other island economies, e.g. Barbados and Bahamas, which rely almost totally on imported food. As such, natural shocks due to the weather have very little impact on food prices in such countries as opposed to the situation in Jamaica.
It brings into question an issue which has been discussed by technicians in Jamaica as to the need for a refinement of the measure of inflation.
A simple example will illustrate the point. Given the relationship between interest rates and inflation, is it rational that a short-term shortage of domestic foodstuff, which converts to higher domestic food prices, should impact on interest rates? This is an issue worthy of serious inflation.
This is in no way meant to question the accuracy of the measurement of inflation based on the CPI basket. It is only meant to question whether this same measurement of inflation should be applied for all aspects of national economic planning.
I next turn to Mr. Chang's discussion of inflation causation. He ridicules the notion advanced by "some members of the media and politicians", that inflation is affected by rising exchange rates. Rather, he asserts that the causation is the other way around.
Mr. Chang is right, in part, in that persistent inflation - erosion of the purchasing power of the domestic currency - must have an impact on the exchange rate in terms of the purchasing power of the Jamaican dollar vs the currencies of our major trading partners.
However, he is absolutely incorrect to argue that a deteriorating exchange rate has no impact on inflation. The fact is that while inflation is a major contributory factor to currency depreciation, it is not the only factor.
There are several instances in which other 'factors', including the intangible - 'confidence' - comes into effect. In other words, there can be situations where inflation is under control but because of an absence of 'confidence' in macroeconomic management, holders of wealth will choose to shift resources, demanding foreign exchange and in turn, surrendering their Jamaican dollars. This inevitably leads to a depreciation of the Jamaican currency.
Omar Davies, MP
Opposition Spokesman on Finance
published: Sunday | January 13, 2008
THE EDITOR, Sir:
Your columnist, Kevin O'Brien Chang, in his wide-ranging piece on Sunday, January 6, sought to contribute to the debate on the exchange rate assumption which was made by the Ministry of Finance, in constructing the 2007/2008 fiscal budget.
He argues that by assuming a rate of J$71 to the U.S. dollar, as indicated by Prime Minister Golding in Parliament, the past administration would have known that inflation would have been at a double-digit rate, rather than the six-eight per cent range which was announced in the economic programme. The clear implication of his assertion is that the administration in general, and I, in particular, had deliberately misled the country in this matter.
He bases the assertion of "prior knowledge" by appealing to the "relative purchasing power parity theory" which he argues, has accurately tracked the value of the Jamaica dollar vs the U.S. dollar over the past three years. He goes on to criticise "some media persons and politicians" for failure to understand the real relationship between inflation and the exchange rate.
I welcome Mr. Chang's contribution to the discussion. However, I respectfully suggest that his piece reflects a less-than-complete comprehension of the complexity of the issues which must be taken into consideration in (i) analysing the casual factors affecting inflation in Jamaica; (ii) defining the relationship between inflation and exchange rate; and, (iii) in preparing the Estimates of Expenditure for a fiscal year.
exchange rate
Let me begin with the matter of the construction of the Estimates of Expenditure. Given that these estimates are denominated in Jamaican dollars, an assumption has to be made about the rate of exchange at which external obligations - in particular debt - will be settled during the fiscal year.
The technicians at the Ministry of Finance have developed the practice of using a rate of exchange which minimises the level of additional dollars needed even if the exchange rate moves against the projected trend. Put another way, it is far more desirable from the budget's point of view, to have overprovided Jamaican dollars for settling external obligations than to have underprovided. Any such under- provision will logically imply including additional resources to be included in the Supplementary Estimates.
We do not have to look very far for concrete examples of the conceptual point mentioned above. In the Supplementary Estimates which were recently approved by Parliament, there are several examples under Head 201A (Interest Payments) as well as under Head 2000A, where there are additional requirements resulting from the fact that the exchange rate has moved beyond that which had been projected.
I would recommend that Mr. Chang, as well as any other persons interested in the topic, peruse the document and see the point which I am making.
I now turn to the issue of Mr. Chang's assertion that the Govern-ment must have known in advance that it would not have been possible to attain single-digit inflation. Clearly, the fact that there are now additional requirements for external debt servicing indicates that even if Mr. Chang's assertion were correct, the present administration has now overshot the projected exchange rate.
However, there is a more substantive point to be made about the ability to project an inflation rate, which Mr. Chang has not fully grasped. In fact, it is related to a criticism he has made of the stewardship of Governor Latibeaudiere in terms of the inflation outturn in Jamaica vs our major trading partners.
In layman's terms, one can differentiate between 'core inflation' and 'headline inflation'. Core inflation is mainly related to the expansion in money supply.
'headline' inflation
We can contrast this with 'headline' inflation', which then takes into consideration price movements which are either due to one-off actions or are due to developments totally out of control of local authorities, e.g. movements in the prices of critical inputs of price movements related to the vagaries of mother nature. In those instances, it is impossible for anyone to project what increases will result and as such, these are not subject to control by policymakers.
In Jamaica's case, we face an interesting policy dilemma specifically as it relates to support for domestic agriculture. Given the weighting of food in the CPI basket and further given the importance of domestic food production/consumption in our national economy, any major shortage in domestic food output invariably translates into higher prices with a significant impact on the overall CPI basket.
This is particularly so in Jamaica as opposed to other island economies, e.g. Barbados and Bahamas, which rely almost totally on imported food. As such, natural shocks due to the weather have very little impact on food prices in such countries as opposed to the situation in Jamaica.
It brings into question an issue which has been discussed by technicians in Jamaica as to the need for a refinement of the measure of inflation.
A simple example will illustrate the point. Given the relationship between interest rates and inflation, is it rational that a short-term shortage of domestic foodstuff, which converts to higher domestic food prices, should impact on interest rates? This is an issue worthy of serious inflation.
This is in no way meant to question the accuracy of the measurement of inflation based on the CPI basket. It is only meant to question whether this same measurement of inflation should be applied for all aspects of national economic planning.
I next turn to Mr. Chang's discussion of inflation causation. He ridicules the notion advanced by "some members of the media and politicians", that inflation is affected by rising exchange rates. Rather, he asserts that the causation is the other way around.
Mr. Chang is right, in part, in that persistent inflation - erosion of the purchasing power of the domestic currency - must have an impact on the exchange rate in terms of the purchasing power of the Jamaican dollar vs the currencies of our major trading partners.
However, he is absolutely incorrect to argue that a deteriorating exchange rate has no impact on inflation. The fact is that while inflation is a major contributory factor to currency depreciation, it is not the only factor.
There are several instances in which other 'factors', including the intangible - 'confidence' - comes into effect. In other words, there can be situations where inflation is under control but because of an absence of 'confidence' in macroeconomic management, holders of wealth will choose to shift resources, demanding foreign exchange and in turn, surrendering their Jamaican dollars. This inevitably leads to a depreciation of the Jamaican currency.
Omar Davies, MP
Opposition Spokesman on Finance
Comment