Financial Sector Reform in Jamaica During 1985-1992, Possible Lessons for the Caribbean


WP/95/90-EA
Financial Sector Reform in Jamaica During 1985-1992, Possible Lessons for
the Caribbean by David Marston



There have been two distinct phases in the use of indirect instruments
in Jamaica. The first encompassed the period 1985-1989. In this period,
interest rate controls were removed, a program to remunerate reserve
requirements was instituted, and the liquid assets ratio (LAR) was phased
out. Open market-type operations replaced credit ceilings as the primary
instrument of control. The period 1989-1991 saw significant reversals, as
credit ceilings were reintroduced and the LAR reimposed in response to a
surge in credit and exchange rate pressures. A second phase in using
indirect instruments was started in late 1991, coincident with the adoption
of a more liberal foreign exchange system.

This paper argues that, while it was fairly simple to remove interest
rate restrictions on the intermediation process in Jamaica, consensus on
policy-induced interest rate movements has been more difficult. Because of
this dichotomy, while indicators of intermediation and banking efficiency
improved consequent on the reforms, monetary control was more elusive, owing
to weak fiscal performance and quasi-fiscal pressures on monetary policy.
In contrast, from the standpoint of monetary control, greater stability has
been associated with the currency board-type arrangement of the Eastern
Caribbean Central Bank. The paper notes, however, that this outturn masks
fiscal pressures among some member countries of the currency union, which,
while not monetized, have been largely financed through arrears. This mode
of financing inhibits market development and could conceivably threaten the
union.

Some of the issues that affected Jamaica's use of indirect instruments
(quasi-fiscal pressures on money supply, disintermediation arising from
unremunerated reserve requirements and interest rate caps, and inappropriate
policy mix in the context of fixed exchange rates) are also evident in
other Caribbean countries. The paper argues that, independent of the
conclusion of the current debate in the region on currency regime, the
resolution of these issues is crucial to the success of financial sector
reforms now being pursued in these countries.