The Evolving Role of Central Banks
Chapter

22 Jamaica’s Transition from Direct to Indirect Instruments of Monetary Policy

Editor(s):
Patrick Downes, and Reza Vaez-Zadeh
Published Date:
June 1991
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Author(s)
G. ARTHUR BROWN

The transition from direct to indirect instruments of monetary policy in Jamaica commenced in 1985 and was a major policy initiative by the Government. It formed an important part of the policy framework that was established within the context of the Financial Sector Reform Program adopted by the Government of Jamaica under the auspices of the World Bank. The program was geared toward eliminating certain macroeconomic impediments to efficient financial sector intermediation. It was also intended to implement certain monetary policy reforms that were deemed necessary for improving resource allocation and mobilization in the monetary and banking system.

Up to 1985, the major factor affecting the efficiency of the monetary and financial sector had been the large fiscal deficits, which required substantial financing by the banking system—provided mainly by the imposition of a liquid assets ratio. This created much difficulty in separating monetary policy from fiscal policy and in enabling the Bank of Jamaica to pursue an independent monetary policy.

Another important aspect of macroeconomic policy considerations in 1985 was the search for a realistic exchange rate determination mechanism. An auction market for foreign exchange had been established since 1983, but over the two-year period, the parity of the Jamaica dollar fell from J$ 1.78 to US$1.00 in 1983 to J$5.50 to US$1.00 in 1985. As a consequence of this rapid depreciation, the stability of the par value of the nominal exchange rate became a major policy goal of the Government in 1985. This meant that overall economic policy was directed at anchoring the par value of the Jamaican dollar to the U.S. dollar at a fixed rate (J$5.00 = US$1.00 at the end of January 1985), with domestic monetary policy being formulated and implemented to support the achievement of this objective.1

Prior to 1985, the Bank of Jamaica relied solely on direct instruments of control to execute monetary policy. The main instruments were variations in the liquid assets ratio of the commercial banks, an administrative floor on the savings deposit rate, and selective and quantitative controls on credit expansion. The liquid assets holdings of the commercial banks were mainly cash reserves, treasury bills, and local registered stock issued by the Government. Treasury bills were short-term government instruments with a 90-day maturity. Local registered stock, which qualified as liquid assets, were long-term government securities with a remaining period to maturity of nine months or less. Variations in the liquid assets ratio of the banks were used to adjust the distribution of credit between the private and public sectors. But the instrument lacked efficiency because it distorted the pattern of credit allocation. The minimum savings deposit rate, because of its direct impact on lending rates, was used as an important support for demand management programs. Quantitative controls on credit were intended to regulate the amount of credit that was available to the private sector and hence to influence monetary expansion. But loopholes existed that led to the avoidance or circumvention of the restrictions.

It was in the context of this exposure with direct controls that a complete revision of the system of monetary management was adopted. Not only was there a need to reverse the inherent distortions in the system but also there was a need to equip the Bank with a range of instruments that had the requisite flexibility and were efficient.

The Bank of Jamaica and the World Bank, therefore, issued a joint memorandum on monetary and fiscal policies that focused on four main areas: (1) the need for base-money management; (2) rediscounting transactions of the Bank of Jamaica; (3) open market operations; and (4) other policy measures to support base-money management and improve financial intermediation in general.

The first section of this paper reviews and analyzes those measures that were undertaken by the Bank of Jamaica to develop open market operations and implement a program of base-money management in the 1985-89 period. The development of open market operations has been the most significant monetary policy initiative undertaken by the Bank of Jamaica in implementing reforms of the financial sector. From the conceptual perspective of base-money control, open market transactions are expected to operate mainly in influencing changes in the monetary base.2 Other policy instruments relating to the pattern of rediscounting transactions and liquidity support are also briefly examined in this section. These instruments were also expected to have an impact on the monetary base. In the second section, the impact of other instruments of monetary policy is examined. Here, the phasing out of some instruments of direct control is reviewed. This is interpreted as part of the movement toward indirect, rather than direct, monetary policy formulation. The third section deals with some operational procedures, including the prudential supervision of bank risks arising from the changes that were introduced. The last section provides a summary and conclusion in respect of the main findings of the paper.

Transactions Undertaken to Influence Changes in the Monetary Base

In support of the primary objective of exchange rate stability and relatively low inflation, open market operations, which commenced in the fourth quarter of 1985, were designed to contain the monetary base. The initial issue was J$50.0 million, but as demand pressures intensified the stock of the Bank’s certificates of deposit expanded to J$2,425.9 million at the end of December 1989. The market for certificates of deposit evolved rapidly in the initial year of operation in 1986, with outstanding certificates totaling J$l,010.0 million. There was a relative slowdown in 1987, but the market expanded sharply in 1988 to reach J$2,299.6 million in outstanding certificates. The year 1989 saw a marginal expansion in their stock, a consequence of intense speculative pressures and the low preference for Jamaican dollar assets.

The certificate of deposit is a short-term instrument with a maturity ranging between one and nine months, but the bulk of the outstanding stock during the period was three-month securities. The rate of interest is generally determined through an auction, but the Bank has at times fixed the yield or placed a cap on the interest rate that it will accept. The amounts offered by the Bank of Jamaica vary on the basis of policy considerations. During 1987, unlimited amounts were offered because much emphasis was placed on mopping up excess liquidity in the banking system.

Commercial banks account for the single largest share of the market, or about 45 percent of the volume of outstanding certificates issued over the five-year period. Sales of certificates of deposit by the Bank of Jamaica were expected, in principle, to contract and purchases to expand base money, thereby leading to a corresponding contraction or expansion of the money supply; however, during the period, the Bank made no purchases. Sales of certificates of deposit to the commercial banks were the only type of transaction carried out by the Bank. This situation was linked with the need for sustained demand management action and reflected some substitutes consequent to the phased reduction of the liquid assets ratio.

In the past, the liquid asset requirement had distorted the pattern of credit allocation and provided resources to government at subsidized rates of interest. Its removal was, therefore, one of the major goals of the reform program. The phasing out of the liquid assets ratio was to be achieved according to the following schedule, 48 percent by March 1985; 44 percent by March 1986; 35 percent by March 1987; 25 percent by March 1988; and 20 percent by March 1989.

Open market operations in the period, however, had little impact in influencing changes in base money, since the banks held very little excess cash balances over the statutory cash reserve requirement of 20 percent, which existed for most of the period. This was a very high statutory cash requirement and it imposed substantial costs on the banks. It meant that the banks were inclined to hold only minimal excess balances, under normal circumstances. The restrictive nature of the high cash reserve ratio was emphasized by the requirement that the banks maintain this ratio on a daily basis. Open market operations in certificates of deposit, therefore, had their main influence on the money multiplier, through their impact on short-term interest rates, rather than through variations in reserve balances held by the commercial banks.

The data shown in Table 1 indicate marginal excess cash balances for most of the period that showed no apparent link with the variation in balances of certificates of deposit held by the banks. On the other hand, the large overall excess liquidity could be associated with the change in the statutory requirements (Chart 1). The source of the banking system’s liquidity after the third quarter 1988 and part of the buildup of excess liquidity was related to large reinsurance inflows from overseas following the destruction caused by Hurricane Gilbert in September of that year. Certificates of deposit were used extensively to mop up excess liquidity, but large excess cash and liquid balances still remained in the system. The table also shows some substitution between holdings of certificates of deposit, on the one hand, and treasury bills and local registered stock, on the other.

Table 1.Liquid Assets and Currency/Deposit Ratios of Commercial Banks
QuartersCashDeposits with Bank of JamaicaTreasury BillsLocal Registered StockMoney at CallSpecified AssetsTotal LiquidityExcess LiquidityCurrency/ Deposit1Excess Cash Reserves
1985
First quarter1.218.712.811.10.14.148.04.0
Second quarter1.121.814.710.04.051.63.6
Third quarter1.222.516.09.64.153.45.9
Fourth quarter1.421.913.39.84.050.42.40.21.9
1986
First quarter1.221.615.29.32.649.95.93.91.6
Second quarter1.222.414.78.12.548.910.95.02.4
Third quarter1.322.113.68.12.647.79.76.42.1
Fourth quarter1.721.213.27.92.546.58.58.11.2
1987
First quarter1.321.011.77.72.243.98.99.21.0
Second quarter1.222.710.46.52.142.97.98.92.7
Third quarter1.221.611.46.32.142.67.67.01.6
Fourth quarter1.521.010.76.21.941.36.38.21.0
1988
First quarter1.220.910.35.21.338.918.98.30.9
Second quarter1.121.313.46.642.422.47.41.3
Third quarter1.429.411.74.00246.726.711.19.4
Fourth quarter1.730.914.82.90.751.031.013.210.9
1989
First quarter1.331.413.22.00.248.128.115.011.4
Second quarter1.231.99.40.40.443.323.316.711.9
Third quarter1.325.87.60.30235.215.212.16.6
Fourth quarter1.626.77.30.636.216.211.77.7
Source: Statistical Digest, Bank of Jamaica

Outstanding holdings of certificates of deposit expressed as a percentage of average deposit balances.

Source: Statistical Digest, Bank of Jamaica

Outstanding holdings of certificates of deposit expressed as a percentage of average deposit balances.

Chart 1.Actual and Statutory Liquid Assets Ratio of Commercial Banks

(In percent)

The excess liquidity that existed in the banking system for most of the period meant that the need for refinancing as a tool for regulating the stock of reserve money was limited. In 1986, a new Liquidity Support Facility was established to manage transactions at the margin. From the facility’s inception, access to it was restricted. Support was limited to a maximum of two applications a month, not exceeding a total of five days, and the rate of interest charged was initially ⅙ of 1 percent a day, but later was linked to the highest lending rate charged by the commercial banks.

The factors affecting the demand for currency held by the public—the other component of base money—remained largely outside the direct control of the Bank of Jamaica. Interest rate policy was expected to affect, indirectly, the demand for such balances however. Changes in the exchange rate were also expected to influence changes in the demand for currency. There were also “nonmonetary” factors, such as the cash requirements of a large underground economy, capital flight, seasonal demand for transactions balances, etc., which would have caused changes in the demand for currency. The overall impact of these factors has resulted in much variability in this component of the demand for base money. This appears to have been the principal cause of variations in the overall base-money aggregate during the period (see Table 2). The quarterly average proportion of currency to total base money over the period was 32.6 percent, with a significant coefficient of variation (0.10). This indicates the volatility of the currency/ deposit ratio and its likely impact on the money multiplier.

Table 2.Demand for and Supply of Base Money(In percent)
DemandSupply
QuartersCommercial Banks’ ReservesCurrencyTotalBank of Jamaica Credit to Public SectorOther Assets (net)Foreign Assets (net)Total
1985
First quarter68.131.9100.0176.0197.3-273.3100.0
Second quarter72.527.5100.0144.6187.9-232.5100.0
Third quarter72.827.2100.0143.4191.8-235.2100.0
Fourth quarter68.131.9100.0111.1187.9-199.0100.0
1986
First quarter67.732.3100.0160.4149.3-209.7100.0
Second quarter70.629.4100.0164.3121.4-185.7100.0
Third quarter70.229.8100.0180.0121.6-201.6100.0
Fourth quarter64.735.3100.0174.3125.9-200.2100.0
1987
First quarter69.230.8100.0128.7115.5-144.2100.0
Second quarter71.428.6100.093.2109.6-102.8100.0
Third quarter69.130.9100.098.2111.6-109.8100.0
Fourth quarter67.432.6100.083.4111.4-94.8100.0
1988
First quarter69.430.6100.055.0147.5-102.5100.0
Second quarter66.133.9100.058.9149.7-108.6100.0
Third quarter65.035.0100.064.4134.0-98.4100.0
Fourth quarter62.337.7100.040.7121.8-62.5100.0
1989
First quarter64.036.0100.046.4114.0-60.4100.0
Second quarter65.434.6100.047.1100.8-48.0100.0
Third quarter64.835.2100.047.5123.9-71.4100.0
Fourth quarter61.538.5100.060.1121.2-81.3100.0
Source: Monetary Aggregates, Bank of Jamaica.
Source: Monetary Aggregates, Bank of Jamaica.

In searching for an equilibrium position, the Bank’s manipulation of changes in the demand for base money is affected by its capacity to influence the factors relating to the supply of base money. But the characteristics of the supply components of the base shown in Table 2 indicate that only limited control, if any, was possible.

Other Instruments of Monetary Policy

The Bank of Jamaica took some action to remove credit ceilings, but direct controls remained in force for most of the period. For the first half of fiscal year 1985, outstanding credit in the commercial banking system was frozen at the level outstanding at March 31, 1985. But during the second half of the year increases were allowed, which took the outstanding balance to 10 percent above the March 31, 1985 level. In 1986, the global ceilings on bank credit were removed, but ceilings on consumer-oriented credit were retained. These were fixed at the level outstanding at March 31, 1986 and remained at that level until March 31, 1987. For the remainder of 1987 and 1988 global and selective credit ceilings were removed, but in the latter part of 1989 new restrictions were imposed as part of a new stabilization program. Some success can be claimed for the use of these instruments of direct control, if the relative stability of the exchange rate in 1986, 1987, and 1988 is taken as an indicator.

In November 1985, the Bank reintroduced a Pre-Shipment Financing Facility (PSF) and a Bankers Export Guarantee Facility (BEGF) to channel credit to the export sector at preferential rates of interest. The PSF provided credit for raw materials and other intermediate goods to enable companies to meet the demands of the export market. The BEGF provided financial resources to bridge the period between the exports of goods and services and the actual foreign exchange receipts. A Bankers Rediscounting Facility (BRF) was also in operation at the beginning of the period; this was used to channel funds at preferential rates to the agricultural, construction, manufacturing, and tourism sectors. Highly preferential rates of interest were provided for agriculture, but the subsidy for construction, manufacturing, and tourism was less. These were all examples of the use of the rediscounting facility to channel funds to certain preferred areas and to introduce some degree of flexibility into the process of credit allocation so as to stimulate productive activity in the economy. But the use of the discounting facility as a tool of monetary policy, although used several times during the period, had little impact on the overall monetary aggregates.

The cash reserve ratio was used as an active instrument of policy in 1985. During that year, the ratio was changed four times, increasing from 14 percent to 20 percent. It remained at that level until it was reduced to 19.0 percent in July 1989. In July 1986, the Bank of Jamaica commenced paying interest on the cash reserve account up to a maximum of 3 percent of prescribed liabilities held by the banks. The rate of interest was the same as that earned on similar balances. In July 1989, the Bank discontinued the payment of interest on any portion of the cash reserves held by the commercial banks. The inflexibility of the cash reserve ratio as a policy instrument was emphasized by the fact that at 20 percent only a small upward adjustment of the ratio was possible without an amendment of the law. The payment of interest on a proportion of the reserves was intended to reduce upward pressure on interest rates.

Transactions in certificates of deposit were effective in generating market forces that led to changes in short-term interest rates, with the savings deposit rate indexed to a combination of market rates. Interest on savings deposits forms a large component of bank costs, so that changes in these rates were an important instrument for increasing bank lending rates and stabilizing the demand for bank credit. In 1985, for example, when there was an urgent need to reduce domestic demand and stabilize exchange rate movement and balance the external accounts, the minimum savings deposit rate was raised three times, taking the rate from 13 percent to 20 percent. In contrast, there were two reductions in the minimum rate in 1986, which resulted in a reduction of the rate to 15 percent. There were no changes in 1987, but in 1988 the rate was reduced further to 13 percent. In 1989, the rate was again increased, to 18 percent, as the exchange rate came under increased pressure. The savings deposit rate, therefore, assumed the role of a major policy instrument in the manipulation of changes in the level of interest rates. Selected interest rates for the period are shown in Table 3.

Table 3.Selected Short-Term Interest Rates
QuartersSavings Deposit RateCertificate of Deposit RateWeighted Deposit RateWeighted Lending RateTreasury Bill Rate
1985
First quarter15.0017.720.6017.13
Second quarter20.0018.522.2718.97
Third quarter20.0018.527.5419.27
Fourth quarter20.0019.628.9521.28
1986
First quarter20.0027.8920.029.2023.75
Second quarter16.0021.0018.526.3523.17
Third quarter15.0018.0016.124.9817.49
Fourth quarter15.0018.0014.824.9015.93
1987
First quarter15.0018.0014.424.7016.87
Second quarter15.0017.5014.824.9118.32
Third quarter13.0018.0015.124.8418.76
Fourth quarter13.0020.0015.524.5919.61
1988
First quarter13.0018.3715.624.8619.68
Second quarter13.0018.3714.924.3619.61
Third quarter13.0017.0814.324.3518.11
Fourth quarter13.0017.5014.324.2618.00
1989
First quarter13.0017.6414.423.6817.82
Second quarter13.0018.5415.023.5417.91
Third quarter13.0020.9016.224.1019.95
Fourth quarter18.0025.1120.228.2623.59
Source: Statistical Digest, Bank of Jamaica.
Source: Statistical Digest, Bank of Jamaica.

A combination of ceilings on bank credit and interest rates contributed to the buildup of liquidity in the banking system and affected the money multiplier when the ceilings forced the banks to hold excess cash balances. Interest rates directly affected the demand for and supply of money and credit and also affected the multiplier when they caused shifts in the proportion of currency to deposits that the public wished to hold. Apart from these factors, there were the nonmonetary factors affecting changes in the money multiplier, such as the seasonal demand for currency. For the 1985–89 period, these factors combined to create much variability in the quarterly money multiplier. Over the period, the average quarterly money multiplier was 2.6628 with a significant coefficient of variation. This relatively high degree of variation in the context of base money management indicated the volatile impact of the money multiplier on monetary expansion. The data are shown in Table 4.

Table 4.Quarterly Growth Rate of Monetary Variables(In percent)
Money
QuartersM2Base MoneyMultiplier
1985
First quarter5.7-14.920.6
Second quarter4.723.7-19.0
Third quarter2.53.9-1.4
Fourth quarter10.017.1-7.1
1986
First quarter6.1-11.717.8
Second quarter4.816.3-11.5
Third quarter6.01.05.0
Fourth quarter8.28.5-0.3
1987
First quarter5.13.81.3
Second quarter4.811.2-6.4
Third quarter-0.1-5.04.9
Fourth quarter5.314.3-9.0
1988
First quarter3.9-3.57.4
Second quarter8.75.13.6
Third quarter9.04.44.6
Fourth quarter13.324.3-11.0
1989
First quarter-1.0-3.02.0
Second quarter-0.9-1.40.5
Third quarter2.9-3.16.0
Fourth quarter5.312.8-7.5
Source: Monetary Aggregates, Bank of Jamaica.
Source: Monetary Aggregates, Bank of Jamaica.

The table shows that for most quarters an inverse relationship existed between changes in base money and those in the money multiplier in respect of their impact on the growth of the money supply.3 This was most evident during the fourth quarters, when large positive changes in base money were associated with the sometimes large contraction in the money multiplier. During the first quarters, except for 1987, the pattern is reversed, with the changes due to base money being negative while those emanating from the multiplier were positive. A less clear-cut pattern emerges in some of the other quarters but, in most of them, the negative relationship between changes due to the base and those of the money multiplier is evident.

The volatility of the money multiplier appears to be related primarily to changes in the currency/deposit ratio. In the fourth quarters, for example, the public’s demand for currency rises sharply to finance a high level of transactions related to the holiday season. This increase in the demand for currency has a positive impact on the expansion of base money but a negative one on the money multiplier. This results from the drawdown of deposit balances by the public and their contraction conversion into currency. As the monetary base expands, the ratio of currency to deposits rises, thereby leading to a reduction of the money multiplier. During the first quarters, the process is reversed. The liquidation of currency holdings is replaced by an increase in business sector deposits in the commercial banks. Hence, base money contracts, but the impact of the money multiplier correspondingly increases as the currency-to-deposit ratio falls. Other factors could possibly offset these changes, but evidence so far indicates the dominance of the currency/deposit relationship.

The thinness of the local money market and the absence of a well-developed secondary market for securities appear to have contributed to the volatility of the changes in the currency/deposit ratio. The existence of a developed capital market in which portfolio balances are more widely spread means that base money expansion arising from an increase in currency demand will have a less direct impact on changes in the currency/deposit ratio. This will also lead to less volatility in the money multiplier. This instability of the money multiplier in Jamaica has complicated the process of base-money management. It could also be an obstacle to the successful implementation of base-money control in other countries where money and capital markets are relatively thin and undeveloped.4

Operational Procedures

As part of the operational procedures for monitoring the transition to a more market responsive environment, the Bank of Jamaica established an Open Market Committee comprising its senior managers and chaired by the Governor of the Bank. The Committee supervised the sequencing and supervision of new policy initiatives to ensure their consistency with other aspects of the overall policy framework. In its supervision of open market policy the Committee received weekly reports on money, credit, base money, interest rates, etc., and their performance in regard to prescribed targets, and then advised the Operations Department of the Bank of the targeted open market sales. The Committee also examined applications for liquidity support and other discretionary facilities, such as the discount window, operated by the Bank.

The actual operation of the market for certificates of deposit has been relatively simple, based as it is on only one type of transaction. Press releases provide information on the amount of a new offer, the date of issue, the maturity date, and the length of the tenure. Tenders are submitted at least one day before the issue date in sealed envelopes to the Bank. Applicants state the volume that they require, as well as the proposed rate of interest. When the rate is fixed by the Bank, the applicant states only the amount that is required. Applications are vetted by senior administrative personnel of the Operations Department of the Bank to ensure that they comply with the rules of the tender. But the decision concerning the rate of interest to be accepted and the volume of qualified bids is made by the Open Market Committee of the Bank.

The monetary policy changes and other developments in the financial sector have resulted in a revision of the legislation that governs the activities of the Bank of Jamaica and the commercial banks. This is expected to strengthen the legal basis for further development of base-money management. Other amendments will set legal minimum ratios for both reserve and liquidity balances. There are also amendments that are aimed at giving increased powers to the Bank of Jamaica, a move that will increase the independence of the Bank in the implementation of policy.

With regard to the commercial banks, the proposed amendments aim to reduce the growth of monopoly power within the sector by limiting the links with nonfinancial entities. The proposed legislation seeks to prevent large-scale equity participation by commercial banks in nonflnancial entities.

Supervisory operations of the Bank Inspection Department have been increased during the period to allow for increased monitoring of the banks’ balance sheets and profit-and-loss accounts. The banks were required to adopt a new reporting format, and accounting guidelines have been revised and updated. Liquidity and interest rate monitoring have also been increased, the main focus being the monitoring of short-run liquidity risks. Banks have also begun to report off-balance sheet items, such as commitments and guarantees, which, if met, affect the banks’ liquidity and therefore become balance sheet assets or liabilities. Many of the off-balance sheet commitments are facilities that borrowers may use whenever they wish, and can thus be considered as ways of circumventing the credit restrictions.

Summary and Conclusion

The phasing out of the statutory liquid asset requirement in the commercial banking system was carried out in accordance with the scheduled program that had been agreed to with the World Bank. Because the statutory liquidity requirement was generally below actual levels of liquidity, there was some substitution between treasury bills and certificates of deposit. More substantively, however, in defense of price and exchange rate stability in the Bank of Jamaica’s transactions in certificates of deposit, the substitutions were devoted solely to reducing, rather than augmenting, liquidity levels in the banking system. This led to some lack of dynamism in the market for certificates. High levels of liquidity in the banking system also reduced the role of central bank refinancing as an instrument of aggregate monetary policy. Instead, such refinancing as was carried out by the Bank was used mainly as a tool in the allocation of credit.

In spite of the movement to indirect instruments of policy, selective credit ceilings still remained an important direct policy tool. Given the limited range of financial instruments that were available, the credit ceilings formed an effective, although not efficient, instrument of policy. The cash reserve ratio remains a blunt and inflexible instrument, which has been used only once since 1985. Its inflexibility is emphasized by the fact that at 20 percent the ratio is near the maximum that is permitted by law.

The effectiveness of base-money control was hampered by the instability of the money multiplier. An estimate based on quarterly data shows a high degree of variability in the money multiplier. The reasons for this instability can be traced to the volatility of the currency/ deposit ratio, which appears to be linked to thinness in the local money market. Other developing countries could experience similar problems where money and capital markets are thin.

Base-money control was also hampered by the inability of the Bank of Jamaica to exercise adequate control over the supply of reserve money. As is shown in Table 2, two of the factors influencing the supply of base money are the Bank of Jamaica’s net credit to the public sector and the change in net foreign assets of the Bank. The change in net other assets is the other component in the supply of base money. These net other assets are in fact mainly other elements of credit provided to the public sector by the Bank of Jamaica. They reflect losses of the Bank stemming from policies implemented on behalf of the Government. The nature of these components, together with the absence of any substantial refinancing of commercial banks, indicated minimal control by the Bank over the factors influencing the supply of reserve money. This was an additional difficulty in promoting an effective policy of base-money management.

Interest rate policy reflected a mix of market and nonmarket forces. The savings deposit rate remained an important and frequently used direct instrument of interest rate policy. On the other hand, the rate for certificates of deposit emerged as a freely determined market rate, except in periods when it was fixed by the Bank. In spite of its partially regulated nature, interest rate policy succeeded in generating positive real short-term interest rates in 1986 and 1987. In that sense, the policy could have made a contribution to financial deepening and the long-term development of the money and capital markets in Jamaica.5

The attempt at base-money management encountered substantial difficulty in the period under review, although success was achieved in implementing some of the reforms. The need remains to develop and broaden the money and capital markets. A secondary market for securities, as well as a more vibrant interbank market, needs to be developed. Refinancing as a tool of monetary policy represents another instrument that needs to be developed.

*The author is Governor of the Bank of Jamaica.
1See W. Max Corden, Exchange Rate Policy in Developing Countries, Country Economics Department (Washington: The World Bank, April 1990).
2The principle of base-money control is based on the well-known algebraic relationship: M = k B where M is the money supply k is the money multiplier, and B is reserve or base money. Changes in the money supply are dependent on changes in k, the money multiplier, as well as changes in B, the monetary base.
3The methodology used to separate the impact of the base and the money multiplier on monetary expansion is found in Joachim Ahrensdorf, and S. Kanesathasan, “Variations in The Money Multiplier and Their Implications for Central Banking,” Staff Papers, International Monetary Fund (Washington), Vol. 8 (November 1960), pp. 126–49.
4See Graeme S. Dorrance, “The Instruments of Monetary Policy in Countries Without Highly Developed Capital Markets,” Staff Papers, International Monetary Fund (Washington), Vol. 12 (JulyI965), pp. 272–81.
5See Ronald I. McKinnon, Money and Capital in Economic Development (Washington: Brookings Institution, 1973).

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