Bank of Guyana responds to questions on monetary policy
Banking
By Jerome de Freitas (former lecturer and head of the Physics Department at the University of Guyana)
Stabroek News
April 26, 2007
We asked Mr Patrick Van Beek, an actuary who writes a Business Page column for our Sunday paper to look at the Bank of Guyana's statistical Bulletin (available at Bank of Guyana ) and to prepare some questions.
Question 1
Over 2006 there has been a 19.5% increase in the monetary base as represented by notes and coins issued by the Bank as shown by tables 1.2-1.4. Table 3.1 records the monetary base has increased 20.6%. The money supply has in-creased by 27% while broad money (including demand deposits) has increased some 16%. Conventional monetarist theory dictates that an increase in the money supply in excess of real growth in economic activity is inflationary. Yet despite real GDP growth of 5% in 2006 Guyana's inflation rate has remained around 5%. The large disparity in these figures suggests a substantial proportion of economic activity is going unreported. How does the bank take this (unreported activity) into account when making monetary policy decisions given that the principal objective of the Bank of Guyana Act is "fostering domestic price stability"
Bank's response
First, it should noted that the theory to which you referred was established principally as a general guide, not a proverbial 'hard-and-fast' rule to evaluating the relationship between money and output of the economy.
It may therefore be ill-conceived to pursue a simple evaluation of the growth in the actual stock of money, and its implications, within the context of theory. Other than the natural growth in the economy you highlighted, consideration should also be extended to the expansion of the money supply from external sources, for example, funds in the form of foreign capital to finance investment, and other similar external inflows.
Bank of Guyana
The Bank acknowledges the issues you raised, and wishes to assure you that concerns about inflation and addressed within a structured programme of analysis, with very reliable data which informs on expectations about inflation. You may be aware of the two common types of systems for implementing monetary policy. One is via targeting interest rates, commonly utilized in efficient, well developed financial systems; the other is by indirect control of the growth in monetary aggregates.
The Bank utilizes the latter of these.
Further question
A foreign exchange transaction does not cause the supply of Guyana dollars in issue to increase - merely a transfer between one holder to another. Is the Bank implying there is a substantial amount pool of Guyana dollars held overseas which are not accounted for in the quarterly bulletin?
If not then the only way I see an influx of foreign currency into the economy increasing the G$ money supply would be if the commercial banks were to borrow (take in as deposits) the foreign currency and then lend it out in G$. This kind of activity was one of the factors that precipitated the Asian crises so an increase in the money supply as a result of this kind of activity would normally be viewed as extremely undesirable.
Most economists would regard Growth in Money Aggre-gates to be the same as growth in the Money Supply. I find it a bit difficult to reconcile the view on one hand that a considering a dramatic increase in the money surprise as being inflationary is ill-advised, yet on the other that the bank implements monetary policy tough control of the money supply.
The Bank of England publishes its quarterly forecast on inflation expectations (see here ). Is the bank in a position to include this data in its quarterly statistical bulletins?
Question 2
Graph XI charts the money supply figures from Table 3.1: it highlights a dramatic increase in the monetary base over the last three months of 2006. The commercial banks are now in a period of credit expansion, and the increase in the monetary base would be expected to lead to an increase in broad money by the money multiplier effect. If we take the money multiplier to be the ratio of broad money to narrow money (around 5.5 for Guyana) we can expect the G$4 billion dollar increase in the monetary base in December 2006 to increase broad money by around G$22.5 billion - around 15.6% of broad money at the end of year. Is the Bank not concerned that an increase in the money supply of this magnitude will be inflationary?
The Bank's response
The Bank is in fact very concerned about circumstances that potentially undermine its objective of price stability. If consideration is extended to the content of the first response, it should become clear that it is not prudent to speculate about inflation simply by observing the expansion of money supply. If economic activity is expanding, more money will generally be needed in the system, and the supply of appropriate amounts will preserve economic balance.
The Bank continuously monitors the liquidity in the system and utilizes open markets operations to realign the balance of liquidity to its desired level when the need arises.
Further question
If it is not prudent to speculate about the inflationary impact of a 15.6% increase in the money supply then exactly what would be a circumstance which potentially undermines price stability?
Question 3
Despite a 75 basis point increase in the Bank Rate over 2006, the 91 day Treasury Bill discount rate increased 42 basis points and the 364 day Treasury Bill discount rate increased just 4 basis points (Table 4.1). How does the Bank view the fact that the Bank Rate does not appear to be a signal followed by the money markets? Given the limited impact of the Bank Rate, if there is a spike in inflation, the liquidity in the system suggests an increase in reserve requirements or liquidity ratio will not be effective in reducing the money supply. This leaves open market operations as the only option available to the Bank to increase interest rates and choke off inflation.
The September quarterly statistical bulletin records the stock of Treasury Bills as G$59.6 billion. Is the Bank not concerned that in order to increase interest rates it would have to issue yet more treasury bills, which would dramatically increase the interest cost to the government due to a double-whammy of increasing the stock of debt combined with the increase in interest rates from doing so? A 2% increase in interest rates would increase interest costs by $1billion - or about 1% of the national budget. Would it not make sense to pay a term premium, issue longer term paper and lock into the current low rates of interest?
The Bank's response
The Bank rate is in fact adjusted in line with the general movement in the Treasury bill rate. Entertain-ing your supposition of an inflationary spike, the Bank can indeed move swiftly to respond to such threats.
Agreed, this may result in higher interest costs and an increase in debt, but in Guyana, and one would presume, elsewhere, these are the costs of price stability.
Further question
The bank says: "The Bank rate is in fact adjusted in line with the general movement in the Treasury bill rate"? This suggests that the bank is reacting to the market rate not the other way around.
Question 4
In tables of exchange rates published by the Bank of Guyana GBTI's rate selling rate for USD is 201. However recent transactions carried out at GBTI were taking place at a rate of 204.25. Given that the bank average is used by many as a reflection of the level exchange rates, does the allowance of inaccurate information to be used in this calculation not suggest the Bank is complicit in underreporting the devaluation in the Guyana dollar?
The Bank's response
The monthly exchange rate published by the Bank is computed using weekly average of the mid-rate of the three commercial banks with the largest weekly trading volumes. The quoted rates by commercial banks are usually their rates on offer for over-the-counter transactions. Transactions involving large volumes of foreign currency would likely be offered rates other than those published.