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WHAT MATTERS MOST: Traps facing island

DR CLYDE MASCOLL, [email protected]

WHAT MATTERS MOST: Traps facing island

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THE FAILURE to appreciate that Barbados is experiencing a peculiar form of the liquidity trap, rather than being a prolonged victim of the international economy and institutions, is costing the country dearly. National income, production and employment are all already trapped at low levels.

The peculiarity comes from the fact that the policymakers’ single-minded focus on propping up the Government’s poor fiscal management has crippled the households’ ability to contribute to national income growth and the businesses’ power to increase production and create employment. Rather than accept that the country has a major fiscal problem, everything is still being done to accommodate the fiscal folly.

The most recent policy of allowing commercial banks to fix the deposit rate is worthy of context. It speaks to the ongoing desire to keep the country trapped, while certain segments survive. It may also speak to a bigger long-term desire given the ownership structure of the financial sector.

There is a notion that once ways can be found to finance the Government’s fiscal deficit, the country will remain in survival mode. Therefore economic growth of 0.2 per cent in 2014 is held up as success. A reduction in the foreign reserves is masked by changing the reporting periods.

As far back as 2011, the Central Bank declared that commercial banks had little appetite for further investment in Government long-term securities, typically packaged as debentures. They preferred to buy more short-term securities in the form of treasury bills. As a result, the Central Bank became a major purchaser of both types of Government securities.

In previous economic downturns in Barbados, the increased demand for Government securities was accompanied by a higher interest rate. This time around, the Central Bank, not the private sector, was the major purchaser and so the interest rate did not increase.

In the meantime, commercial banks’ profitability took a hit. In spite of the money in the banks, Barbadian households were not borrowing and businesses were being challenged by the lack of economic activity and confidence in Government policies. Commercial banks were forced to make adjustments to costs which meant reduced employment. This happened in the last couple of years.

Therefore the return to profitability in the banking sector was triggered by cutting cost which cannot be sustained.

Given that the economic challenging times have persisted, lending as the primary way of earning income remained difficult for the commercial banks. No wonder, customers started to cry out for the imposition of a charge on every conceivable transaction.

Having found little appetite for Government securities since 2011 and no significant increased demand for borrowing, the commercial banks continued to have excess money or liquidity. In the last year, they placed well over $300 million more in excess reserves with the Central Bank. This money has served the Bank well.

It has allowed the Central Bank (the monetary authority) to print money without damaging the foreign reserves – the monetary authority is the name given to the entity that controls a country’s money supply. When the printed money is added to the foreign reserves, the result is called the monetary base. The latter is identically equivalent to the sum of currency and bank reserves held at the Central Bank. 

The method of putting excess reserves with the Central Bank comes at a cost to commercial banks because no interest is paid on the reserves. The quid pro quo is the removal of a minimum rate on deposits by the Central Bank. This permits commercial banks to lower the deposit rate and earn income without reducing lending rates.

Furthermore, Barbados is experiencing its own peculiar liquidity trap where low deposit rates are not resulting in lower lending rates to stimulate investment. They will however reduce the cost of Government securities, especially short-term, and give households less income.

Fortunately, while the Bank was printing money and the commercial banks were accommodating the ongoing action, international oil prices also declined and protected the foreign reserves. These circumstances are not sustainable.

However, the existing traps on national income, production and employment are now further compounded by a peculiar liquidity trap.  

• Dr Clyde Mascoll is an economist and Opposition Barbados Labour Party adviser on the economy. Email [email protected]