Inflation: causes and influences on the Jamaican Economy

Published on February 17, 2005 By Paul Bourne In Politics

Mishkin (2003, pp.11) posits that inflation is a monetary phenomenon. This is created by ‘more money chasing too few goods’. If goods and services are scarce in a particular locality, an increase in money supply will fuel a higher valuation of the same commodities. The reality here is businesses and government are forced to pay higher costs for products. This phenomenon affects the economy. Wilson (1982, pp.118) concurs with Mishkin’s position, when he forwards the argument that government’s monetary policies directly influence general prices throughout the economy. Further, he writes that:

“Inflation is a persistent rise in some general index of prices that, due to expectations, becomes self-supporting. Yet not all prices rise, or do they rise by the same extent. Inflation therefore results in a form of income and wealth redistribution totally unrelated to any desirable goal of either economic or social policy.”
George Wilson (1982:pp.118)

Jamaican governments for many years have tried to combat the scourge of inflation and its consequences on the populace, but this is to no avail. Mishkin (2003) in his book titled ‘The Economics of Money, Banking and Financial Markets’ asked the question, “What explains inflation?” He posits that one clue is money supply generally and the price levels. He argued that, “continuing increase in the money supply might be an important factor in causing the continuing increase in the price level that we call inflation”. Hence, inflation is inextricable linked to the continuous increase in money supply. Mishkin (op cit) posits that, government’s concern about inflation is its monetary policy given the direct influence between money supply and price levels.

The maintenance of price stability is one of the main objectives of governments throughout the world ever since the dawn of finance, as this issue affects the lives of everyone. One economist, states “the absence of fiscal and monetary discipline breeds inflation, which in turn stifles growth” which is why this issue is of fundamental importance to all. Furthermore, as was previously stated by Wilson (1982), inflation is the general rise in prices and so any movement in this phenomenon influences social and economic policies, incomes, wealth and peoples’ welfare. As such, this issue cannot be felt to the wind as is importance is positively related to man’s welfare and so must be adequately analyze in order that we will be able to effectively deal with its effects, influences and spread (Mishkin, 2003).

According to Wilson (1982) in his article titled ‘Inflation: Causes, Consequences and Cures’: inflation will not persist unless it is accommodated by sustained increase in money supply. Therefore, inflation is fundamentally a monetary phenomenon (according to Mishkin, 2003; it was Milton Freidman’s theorizing). Hence, this is a major factor in the choice of monetary policies by governments. Ever since the early 1990s, when Jamaica experienced annual inflation rates as high as 80.2 percent (see Table 1 – Statistical Digest, 2000) the issue of inflation has become everybody’s concern.

Jamaica gained independence in 1962, and was enjoying strong economic growth (i.e. increase in the production of goods and-or services of one year over another), so much so, that economists and peoples worldwide thought that it would become a first world country, as America and Europe! Imagine that! This therefore meant that Jamaica’s economy was stronger than that of all the other developing countries in the Caribbean and Latin America (ECLAC). Furthermore, in the 1950s the country had an income per capita that was higher than that of entire Latin America. Statistics revealed that between 1952 and the 1962, the GDP of Jamaica grew by 6 percentage points. This sparkling revelation is that, the growth rate was the highest in the Western Hemisphere (World Facts Now – Data-Maps and World Bank Group, statistical data).

However, in the last 25 years, Jamaica has almost no economic growth per person, while developed countries (i.e. first world economies) have grown by 2 percent or more on an average (Hanke and Schuler, 1998). Countries that were economically far behind Jamaica in the 1960s, for example: Singapore, Barbados, and the Cayman Islands, presently have stronger economies. They are no longer plagued by high unemployment, high inflation, and huge debts (both external and internal). Overall, the governments of those countries have been able to boost their economies and maintain that price stability, a target Jamaica has been unable to do.

Since independence between 1962 and 1973; the strong economic growth that Jamaica enjoyed, Gross Domestic Product (GDP) growth, averaged 5 percent per annum has deteriorated to negative growth post 2000. From the years 1973 to 1980, the economy experienced a severe contraction due to negative external shocks and inappropriate domestic policies . This contraction reiterates the fact that the Jamaican economy is highly responsive to international price changes and demand shifts.

Between the years 1987 to 1980, inflation in Jamaica averaged 17 percent2. Since the period previously mentioned, one of the main objectives of the governments is to lower inflation. In 1991, the rate of inflation rose to an alarming 80.2 percent and as such, the government of the day had to implement numerous policies to reduce this reality. In 1997, the average annual growth in prices (rate of inflation) was 9.2 percent falling from 15.8 percent in 1996, and fell to 7.2 percent in 19983 (see Table 1). Those inflation actualities have created hardship for countless peoples. In that, the cost of purchasing goods and-or services became higher and so less was bought with the same original dollar.

According to Desmond Thomas (1998), the ‘maintenance’ of price stability is due to a combination of factors, including the tight monetary policy pursued and the ‘sluggish’ level of economic activity. At the same time that the government is pursuing policies to lower inflation, they are also engaging in other activities to increase it. In that, they have: the growth in the money supply of over 40 percent per year, the increase in public spending which includes large wage increases to government employees every two years, the accumulation of unprecedented levels of international reserves in 1992 and 1994, a policy of sterilization and the doubling of the stock of domestic debts.
The substitutability of short-term debt with money showed up in an increase in the money supply during the year 1991 and 1995. Wage awards in 1993 (demand pull inflation) and the latter part of 1995, and government intervention in 1995 in support of troubled financial institutions increased public expenditures5. All of the above arguments have contributed to Jamaica’s inflationary problems, but the most expansionary and therefore inflationary method of financing a deficit is for the government to borrow money directly from the Central Bank.

According to Schuler (1998), throughout most of the Bank of Jamaica’s history, it has merely been “the printing press of the Ministry of Finance, with no ability to resist the ministries orders to finance government deficits by creating inflation”. Because of this constant inflation creation, Jamaica was ranked at number 90 out of 108 countries in average annual inflation from 1971 to 19916 (Hanke and Schuler).

Although the Jamaican government has been having a difficulty keeping inflation as low as possible, the economy is growing very slowly and is almost stagnant. Hanke and Schuler (1998) believe that the government’s policies have been mainly responsible for Jamaica’s stagnation. They state that a good monetary policy is necessary, but not sufficient for sustained economic growth. Their reasoning explain why, although the government has tightened its monetary policy (contraction policy), to lower inflation and have succeeded there is still stagnant growth of GDP of 0.4 percent, the slowest rate over the four-year period 1996 to 19998. Hanke and Schuler posits that an exceptionally good monetary policy cannot offset the growth-destroying effects of high taxes, insecure property rights, excessive regulation and fear of the future cause of economic policy.

The Jamaican economy began shrinking in 1996 and 1997 (-1.3 and –2.0 respectively see Table 2). The reductions in GDP meant that companies’ profits were less. This meant that businesses had to reduce their productive capacity; many companies collapsed under their debts and went into receivership or were closed down9. For some companies in garment manufacturing it became too expensive to export and returns (i.e. profits) were minute. Many banks had to close for example, the Century National Bank (CNB), and the Union Bank now owns by Royal Bank of Trinidad and Tobago (RBTT) either because of the economic climate or because of poor management. All of this led to many Jamaicans being without jobs and many more lose their jobs by the end of the year. Those redundancies coupled with the high inflationary climate contribute to the continually increased unemployment and change in many governmental social policies.

The high interest rates in both nominal and real terms that were experienced by the economy placed a damper on economic activity. Meaning, high interest rates continue to be persistently higher than the rate of growth of government taxes, which means that the government has to use more and more of its revenue to repay its debts and less and less to other activities. The debts cannot be financed by taxes alone, because it is too small, so the government has three options available to them: (1) to further reduce spending on everything except repaying debts. (2) Default, and (3) to create inflation10.

According Hanke and Schuler, default is unnecessary because the government can make the Bank of Jamaica print all the money it needs to repay its bills. Consequently, inflation has been the usual result in the past, and the chance of it happening in Jamaica's future is close to 99.9 percent. It is 99.9 percent likely because, both intentional and domestic debts continue to increase yearly, to the point where Jamaica probably will not be able to repay all of its debts in the near future. The question arises then, how will Jamaica be able to lower inflation with the government's implementation of tight monetary policies, without having to create more inflation to finance its debts? Where is the solution?

If the government continues current monetary policies, Jamaica will be condemned to low economic growth until the Bank of Jamaica has more credibility, on the other the hand, reducing real interest rates by increasing inflation would destroy the credibility that the Bank of Jamaica gained in1994. Hanke and Schuler believe that the only way out of Jamaica's dilemma of 'high interest rate verses high inflation’ is to reform current arrangements for monetary policy in Jamaica. They believe that the best options for return are most far-reaching. In the case of Jamaica, it means 'stripping' the Bank of Jamaica of its power to issue the Jamaican dollar. Jamaica will then have to change its monetary policy to have a strong economy.

The main reason for Jamaica's dilemma is the type of monetary policy it uses. There are two types. 1) A market led monetary regime - which relies on market forces to determine the supply of money and credit and the effects of the exchange rate and 2) A managed monetary regime. This regime is a system of rules governing who issues money and credit, and how domestic currency is to be treated in foreign exchange, while a managed monetary regime relies heavily o regulations to determine those things (Hanke and Schuler). The type of monetary regime that Jamaica's monetary authority have been practicing is the managed monetary regime, while, some countries such as America uses the market led monetary regime. The regime has caused more harm than good as is shown in the poor performance of the Jamaican economy over the years.

By Paul Andrew Bourne, MSc. (candidate); BSc. (Hons) Economics and Demography; Dip. Edu.
Graduate Assistant
University of the West Indies
Mona Campus
Kingston 7
Kingston, Jamaica
West Indies

Appendix I

Table 1: AVERAGE ANNUAL GROWTH RATE OF PRICES4
YEAR % GROWTH
1988 8.8
1989 17.2
1990 29.8
1991 80.

1992 40.2
1993 30.1
1994 26.8
1995 25.6
1996 15.8
1997 9.2
1998 7.9**
1999 6.8
2000 6.1
Source: Statistical Digest, 2000
* The highest inflation figure ever recorded in Jamaica
** Revised figure in 2000, i.e. 7.9 accepted figure, and 7.2 was discarded

Table 2: Annual Growth Rate of Gross Domestic Product at Constant Prices7
YEARS VALUE
1988 2.9
1989 6.8
1990 5.6
1991 0 .9
1992 1.6
1993 1.7
1994 1.1
1995 0.7
1996 -1.3
1997 -2.0
1998 -0.5
1999 -0.4
Source: Balance of Payment of Jamaica, 1999

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