Under the Bank of Jamaica Act (1960), the conduct of monetary policy is aimed at regulating the growth of money and credit in line with the resources expected to finance economic activity and generate employment, without undermining the conditions of price stability. This is in keeping with the Bank's main objective of safeguarding the value of the domestic currency. The other key objective of ensuring the stability of the financial system is organically related but operationally separate from the conduct of monetary policy.
The focus on price stability is the best contribution that monetary policy can make to the economic and financial welfare of Jamaicans. The Bank views price stability as a state in which inflation is low enough that it no longer has a material effect on a person's economic decisions. The most commonly used measure of inflation is the consumer price index (CPI), which reflects changes in the average price of a representative "basket" of goods and services. This basket includes items that the typical Jamaican buys such as food, beverages, housing, transportation, furniture, clothing, communication, education, recreation and health items. The objective is to bring inflation in line with those of Jamaica’s major trading partners.
Price stability is desirable because high and volatile inflation creates uncertainty in the economy, makes business planning difficult and tends to encourage speculative investments. It also creates hardship for individuals, especially those with fixed incomes such as pensioners. Having stable prices in the economy creates a predictable environment that encourages investment and growth. This is in a context where lower inflation leads to lower nominal and real interest rates. If businesses and individuals are confident that inflation will remain stable they will not react quickly to short-term shocks to prices, for example those arising from the impact of a hurricane, by increasing other prices or wages. In this regard, the Bank in recent years has paid increased attention to monitoring and influencing inflation expectations in the economy.
In formulating monetary policy, the Bank takes into consideration any prevailing and prospective developments in the macro economy, fiscal operations, emerging external sector developments and other relevant market information that would influence liquidity conditions. In particular, identifying the sources of liquidity is a primary concern of the Bank, as the management of liquidity levels will ultimately result in stable prices in the economy.
Since the Bank of Jamaica cannot directly determine the prices of goods and services in the economy, the bank chooses a set of operating and intermediate variables, which have a direct effect on the general price level. Thus, the Bank's monetary policy framework and strategy aims at using monetary targets to achieve the desired objective of price stability. The components of the policy framework are:
1. The definition of the objective of monetary policy: Price stability
In essence, the Bank's control over liquidity is effected through its management of the monetary base, (its operating target). Base money is the monetary aggregate, which is controlled effectively by the Central Bank and hence, provides the channel through which the Bank can manage liquidity levels. Adjustments in the monetary base affect interest rates, which in turn influence the level of credit and money supply, (its intermediate target), through the money multiplier process. Changes in these variables are ultimately aimed at maintaining a stable exchange rate and price level (its objective).
The process described above relies upon a stable and consistent relationship between monetary conditions and the behaviour of the public. For Jamaica, the various channels through which monetary policy changes affect the domestic price level are depicted in Box 1. Within the transmission process, monetary policy actions will first affect the monetary base. The effects of monetary changes will transmit to domestic prices either through the money supply or through changes in the exchange rates. Communication also plays an important role in anchoring inflation expectations and hence assists in keeping prices stable.
Through daily monitoring of its operating and intermediate targets, the Bank of Jamaica can quickly assess whether its conduct of monetary policy is on the right track and can implement corrective action, rather than waiting to see the final outcome on the price level.
OPEN MARKET OPERATIONS (OMOs)
An operating target of policy, e.g. the monetary base and interest rates, is influenced directly by the Bank and can also be varied in order to bring about the desired impact on the policy objective.
An intermediate target of policy, e.g. the money supply or the exchange rate, has three main characteristics:
Money market trading between the Bank of Jamaica and authorized dealers, with the intention of influencing money and credit in the financial system. OMO involves outright sale or purchase of Government of Jamaica (GOJ) securities held by the Bank, and /or repurchase and reverse repurchase transactions.
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