Jamaica Gleaner
Published: Friday | October 22, 2010
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Economists debate pegged exchange rate
Economist Dr Damien King (right) argues against the necessity for a pegged exchange rate while Edward Seaga, former prime minister and proponent of the peg, listens at a Gleaner forum on 'Economic growth and the Role of a Pegged Exchange Rate' at The Gleaner Company, North Street, Kingston, October 15. - Rudolph Brown/Photographer
A group of leading Jamaican economists agreed last week that a pegged exchange rate could lend to stability in the island's economy but mostly held that the more fundamental inhibitor to growth has been fiscal indiscipline: the habit of governments spending more than they 'earn', and so, borrowing heavily.

Not only did they insist that a fixed rate was not a precondition for growth, the majority of the round table worried that a peg, in so far as it limited a country's ability to execute monetary policy, could be catastrophic at times of crisis.

"Is it sufficient to just impose a pegged exchange rate and try to use that as the anchor?" asked Damien King, a professor of economics at the University of the West Indies' (UWI) campus at Mona, Kingston. "Difficult to say, but it's really risky."

Added King: "If you don't fix the fiscal problem, the instability comes out in secular devaluations over time when you have a flexible exchange rate. In the context of a fixed exchange rate, it comes out in periodic catastrophic breaks with the peg."

Only Edward Seaga, the former Jamaican prime minister and fervent advocate of pegging the Jamaican dollar, was an unreserved backer of fixing the exchange rate, while Dr Derick Boyd, a technocrat in Seaga's 1980s government, was sympathetic to it at the round table hosted by Gleaner editors at North Street, Kingston.

Seaga's argument is that in the two decades since Jamaica liberalised its currency market, the economy has remained unstable, producing little or no growth, compared to the period between 1987 and 1989, when he resisted pressure from the International Monetary Fund (IMF) for further devaluation, pegged the currency and generated healthy growth.

"...We have tried this model we have been using for 20 years," Seaga said. "What I am saying today is that we need to trysomething else."

Boyd, now executive director of the Caribbean Centre for Money and Finance at the UWI's St Augustine campus in Trinidad, was sympathetic.

"I find this notion of a pegged exchange rate, or stable exchange rate, an attractive one because it effectively sends a signal about what you are going to do on the other side," he said.

Dr Adrian Stokes, an economic analyst at Scotia DBG Investments, argued that the global picture of growth in countries with fixed, stable or floating rates was mixed, suggesting a peg was no magic bullet.

Like King, he was concerned about the limited capacity to effect monetary policy with a fixed rate, and in the event of a 'hard' peg, the scrapping of the central bank and the institution of a currency board.

"You have no monetary policy in the local economy and, pretty much, fiscal policy is really the tool that you have to control business cycles," he said.

The problem, though, Stokes agreed, has been the absence of political will by governments to manage the fiscal accounts and rein in deficits, which this year is projected at 6.5 per cent of GDP.

"When I look at Jamaica, monetary indiscretions in the past have come from fiscal indiscretions," he said. "The point, therefore, is that any exchange rate, ... even if you are dollarised or you have a currency board, can become unsustainable if you run bad fiscal policies."

And that, according to Dr Owen Jefferson, a retired deputy governor of the Bank of Jamaica, the island's central bank, is a long-standing problem.

"If one goes back to the 1970s, I think at that point in time Jamaica discovered fiscal deficits," he said. "In other words, you didn't need to increase taxes to get additional resources (to run the government)."

Indeed, in the 1970s and in the early part of the 1980s, Jamaica ran a deficit upwards of 20 per cent of GDP, until Seaga, under tutelage from the IMF, began to rein in public-sector spending.

However, panellists agreed that this was not easy, given the pressure and demands from various constituencies.

"In my case, I imposed that fiscal discipline not just on the strength of my own character, but on the basis of using the magic of words: 'The IMF say'," Seaga said.

In other words, he invoked the conditionalities of the IMF to push through difficult policies such as cutting nearly 20,000 public-sector jobs.

Seaga, though, argued that having a hard-pegged exchange rate would narrow the policy focus demanded of the Government, as exchange-rate stability would, of itself, impact inflation rate and inflation - the twin bane of Jamaican finances for a long time.

Seaga used the analogy of juggling balls to explain the dilemma and how he sought to fix it.

"From my experience, I recognised that it is not possible to get that (fiscal) discipline by having three policies as balls juggling in the air at one time. Can't work! You need one ball to juggle that controls the others - a master ball. And that master ball is the pegged exchange rate, because with the pegged exchange rate, you don't need monetary policy," the former prime minister said.

"With the pegged exchange rate, you take care of inflation, you take care of interest rates. If you peg the exchange rate, and those are out of the picture, then you can manage that and go on to other things. That will be the benefit of it."

'Rosy lenses'

However, Colin Bullock, who now teaches at the UWI, Mona, but joined the central bank as a deputy government at the start of Seaga's "golden" period, apparently believes the former prime minister may be recalling events through too-rosy lenses.

Bullock recalled the oil shock and the global recession of the mid-1980s that threw the economy out of whack, but that by 1987, things had begun to recover, with greater inflows of foreign exchange.

"Sometimes we see history with kinder eyes, but the fact is that despite the growth we were having (towards the end of the 1980s), our foreign-exchange system was not in wonderful condition," said Bullock.

"The Bank of Jamaica ran an auction system which had arrears. In other words, money was taken out to be given to favoured companies and there were arrears every week that were mounting."

Additionally, a currency black market had developed, and by the late 1980s Jamaica's net international reserves was US$800 million in deficit.

"It was not a wonderful time in terms of the foreign-exchange market," Bullock said. "In other words, when the foreign-exchange market was liberalised, it was in a context where the pegged exchange-rate system was under tremendous pressure in terms of supplying the normal needs of the Jamaican people. There was a lot of time wasted in terms of trying to deal with problems."

Added Bullock: "Generally, I would say stability, yes. But stability does not have to come from a peg. It can be achieved through a flexible-rate system."


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