New interest rate regime?
The Central Bank appears to be leaning towards an historic change in the way it regulates how much individuals and businesses in Barbados have to repay when they borrow money from lending institutions.
While there has been no official policy change, some of the bank’s economists, led by Governor Dr. DeLisle Worrell, are proposing the introduction of a new interest rate regime, saying “conventional approaches to monetary policy”, including changing the rate at which banks borrows from the Central Bank, “have not produced the intended policy outcomes”.
And while noting that its use of “moral suasion” to influence commercial bank policy changes had worked “reasonably well”, Worrell and company, in a policy paper called Central Bank Intervention†and Interest Rate Policy In Barbados, said it was now proposed that the three-month rate at which treasury bills were sold would be used as its interest rate benchment.
“This approach involves direct intervention in the auction market for three month T-bills, which is intended to ensure that interest rates behaves in an orderly manner and are kept in line with comparable US rates,” the paper said.
“Therefore, other interest rates are expected to be benchmarked against this market determined rate because the failure to maintain smooth adjustments in the benchmark reference interest rate, particularly with reference to the US equivalent rate, may result in destabilising inflows and outflows of funds.
“Two critical factors that will trigger policy intervention are the movements in US T-bill rates and the domestic liquidity conditions. The importance of these variables within the proposed framework was further validated using an econometric approach,” it added.
The recommended changes, proposed by Worrell, Director of the bank’s Research & Economic Analysis Department, Michelle Doyle-Lowe, her deputy Anton Belgrave and other economists Darrin Downes and Kester Guy, also included giving more leeway to commercial banks and other lenders, giving them the freedom “to set loan and deposit rates”.
Worrell and company noted, however, that there would be measures “to protect the savings of households of modest means”.
“Under the proposed framework, the traditional interest rate tools would be managed as follows: a) The Minimum Deposit Rate – will no longer be the bank’s policy rate but will instead be referenced as the minimum savings deposit rate payable. This rate will be set to protect the real value of the savings of private individuals,” the economists said.
“The Discount Rate – the Central Bank’s discount rate will no longer be adjusted to signal the direction of domestic interest rates. Instead the rate will be determined using a base rate of the average three month T-bill rate plus a spread. This framework better reflects the costs associated with raising funds on the interbank market.”
An interest rate in basic terms is percentage of charges people have to repay when they borrow money.
The Central Bank team said the alternative approach to interest rate policy would be a better fit to Barbados’ reality because it “better suits the circumstances of small open economies like Barbados, and is a practical alternative to conventional policy frameworks, which have been ineffective in producing the desired outcomes”.
Tool of monetary policy
“Conventional wisdom is that interest rates are a tool of monetary policy to be used principally in the control of domestic inflation.
However, the scope of monetary policy to control inflation is limited in countries like Barbados, where perhaps 80 per cent of inflation is imported,” the experts explained.
“It has been the experience in Barbados that monetary policy cannot relieve any pressure that might aggravate imported inflation; for instance, it will not achieve low domestic inflation rates in an environment where international oil and commodity inflation is high.
“Moreover, both theory and practical experience indicate that whatever impact interest rates may have on the availability of domestic credit and spending, is attenuated if local banks, firms and households have recourse to funds from abroad,” they added. (SC)