Peter-John Gordon's article 'Debating interest rates', which was published on December 6, has provoked this critique from David Wong, professor of economics at California State University, Fullerton.

I think that Peter-John Gordon's statement that "unfortunately, this discussion (of a high interest-rate policy versus a low interest-rate policy in Jamaica) is taking place with little appreciation of the principles of economics" is very questionable indeed. Certainly, some people who have discussed the interest policy understand the relevant "principles of economics'.

However, Peter-John's statement does raise the question - whether he intended it or not of: What are the relevant "principles of economics" that apply to the discussion of the appropriate interest-rate policy in Jamaica?

Peter-John seems to take himself literally. By principles of economics, he appears to mean the level of textbook discussion of interest-rate determination in Principles of Economics courses. This is fine as a general introduction to the subject of the role of the interest rate in a (closed) capitalist economy viewed statically, but it is not the applicable set of principles of economics for determining the interest-rate policy for the stagnating Jamaican economy that is heavily indebted in the global economy.

Peter-John's elementary textbook discussion of interest-rate determination in Jamaica does not take account of the actual structure of the Jamaican loanable funds market. For the most part, his analysis appears to assume, as does the textbook, a competitive loanable funds market. However, he does allow for a government monopoly on the demand side of the loan market. [By the way, the interest rate is not the price of money, but, as Peter-John correctly notes before he slips into the error of calling it the price of money, the price of borrowing money, i.e., the price of credit.]

monopolistic nature

In this regard, Peter-John points out that if the Government determines how much it wants to borrow, then it must accept the market interest rate and if the Government sets the interest rate that it is prepared to pay, then it must accept the amount of loans that the market supply. Significantly, Peter-John does not allow for monopsony on the credit supply side of the market.

Yet, recently, Professor Don Harris made much of the monopolistic nature of the banking sector in Jamaica. Is the supply side of the loan market in Jamaica peopled by individual savers as Peter-John assumes when he asks: "What is it that influences people as to the interest rate that they should accept when lending their money to the government (or anyone else for that matter)?" or does it consist of a small number of banks, insurance companies, and other financial firms with similar interests?

This is a matter of enormous importance because if there is monopoly on both sides of the domestic loanable funds market in Jamaica, we have a situation of bilateral monopoly and Peter-John's cozy little view of interest-rate determination in Jamaica appears as a fairy tale.

The interest rate will now be determined, according to standard neoclassical economic principles be it noted not by radical or Marxist political economy, by the relative bargaining power between the government on the one side and the private lenders acting in concert to promote their common interests.

monopolistic combination

Also, please note that private lenders acting in concert to promote their common interests does not require any monopolistic combination in violation of local anti-monopoly laws, whether or not they are strictly enforced; all that it requires is for each lender to pursue its own best interest in the common knowledge that all other lenders are doing the same and that the government is going to return to the loanable funds market year after year.

As a person who is familiar with the theory of endogenously generated co-operation in repeated games, I am sure that Peter-John appreciates the basis for what I just said.

The bargaining between the Government and the monopolistic private lenders that determines the "market interest rate" in Jamaica will occur between limits determined at the lower end by the prevailing international interest rate in the global economy and at the upper end by a limit that reflects government desperation for the loanable funds.

Moreover, as Edward Seaga suggested recently, the central bank in Jamaica can also influence the actual interest rate within the limits by jawboning and moral suasion and pressuring the monopolistic banks because it inspects and regulates them and can threaten to use its powers to influence the banks to be "reasonable" in the price they demand for their loans.

This the central bank can do even if it is mainly concerned with regulating the quantity of money in the economy. Of course, the central bank will have to act in concert with the Government in this area, and this requires that the leadership of the central bank is simpatico with the minister of finance. Seaga certainly shows more understanding of these matters than Peter-John when he commented that Audley Shaw may get the assistance of the new central bank governor in lowering interest rates.

I think that I've said enough to show that Peter-John may be seriously misled about the type of economic principles that apply to the interest-rate policy debate in Jamaica.

Only recently, I received a copy of an April 2000 pamphlet by my friend, Professor (Emeritus) Al Francis of UWI (Mona), entitled: The Dynamics of Debt in the Jamaican Economy or Domar vs Omar: The Burden of Debt and the National Income. Although I won't take the trouble here to summarise Professor Francis's nice little article, which uses first-year university mathematics to do the analysis, I think that it's worthwhile to quote parts of his conclusion by way of concluding my remarks about Peter-John's discussion of economic principles.

debt accumulation

"Ultimately, the accumulation of debt in a stagnating economy is unsustainable. It is reasonable to expect that private creditors of the Government will eventually refuse to roll over debt at some point and that potential creditors inside or outside the domestic economy will refuse at some point to lend, given the increasing risk of default.

"Clearly, the Government has to break the cycle of a high interest rate, no growth and accumulating debt. The current focus of policy is evidently the achievement of a relatively stable price level and a related stable exchange rate. The trade-off for modest success with inflation and exchange rate is a consequential crowding out of private investment as it has become more profitable and less risky to buy government paper compared to undertaking real investment. In a nutshell, the opportunity cost of investing [in Jamaica] is too high.

"The no-growth predicament in which the economy finds itself is hardly surprising; the current macroeconomic conditions are inimical to growth." [A.A. Francis, April 2004]

David C. Wong is a professor of economics at California State University, Fullerton. He can be reached at dwong@fullerton.edu. Feedback may also be sent to columns@gleanerjm.com.